Aussie start-up investors hold firm against tech wreck jitters

The flow-on effects of this shift in sentiment is starting to be felt by later-stage private companies. The IPO window has effectively closed, there are fewer $100 million-plus rounds being raised, and US-based investor Franklin Templeton cut the valuation of its Canva holding in one of its funds by a third last quarter (another of its funds left the value unchanged).

Mr Santiago, who has audited most of Australia’s VC funds, said the flow-on effect to smaller start-up valuations typically lags between 12 and 24 months.

However, he supported the local VCs as good stewards of capital, saying in his experiences their processes are robust and transparent.

“[They] are not quick to rush to re-value things upwards or downwards unless there’s very, very strong evidence to back that up,” he said.

“This kind of discipline will probably stand the local sector in good stead as we go into what could be very volatile times.”

All local funds interviewed by The Australian Financial Review, including Blackbird Ventures, AirTree Ventures and Square Peg Capital, broadly adopt the same approach to valuing companies – mainly adjusting valuations only when there has been a new round led by a credible third-party investor. This is true regardless if the valuation shift has been positive or negative.

For the most part, the VCs said this meant their valuations were conservative – often lagging the true value of the businesses – given the fast growth nature of their portfolio companies.

If a company has grown by 50 per cent since its last capital raise – a realistic possibility for a start-up – by holding its valuation steady, its multiple has reduced by more than 30 per cent.

Evaluation frequency

Most early-stage venture capital rounds are done on an equity basis, but as a company matures it’s also common for convertible notes to be raised, which can defer a valuation being set and offer investors a discount later.

Square Peg re-evaluates the value of its portfolio every six months (although it provides quarterly statements to its super fund investors), and does adjust valuations for material changes outside of external investment rounds.

Blackbird revalues its portfolio quarterly, as does AirTree, and both have scope to mark down a valuation if a company is performing below expectations.

In comparison, a fund manager from a well-regarded institutional investor (which invests in both private and public assets) said their fund assessed valuations on a monthly basis.

“I think the onus is on managers now to show why valuations should not fall,” he said.

“My view is that the fall in the tech sector and the stockmarket is a real fall from overvalued levels … I think we’ll see widespread decreases in unlisted valuations. It’s just a question of when.”

Marking up and down

Blackbird Ventures co-founder and partner Rick Baker said the public market influence does not have an immediate or direct flow on to valuations.

“We don’t typically mark investments up or down as public markets rise and fall,” he said.

“However, we do have mechanisms to adjust valuations where there is a sustained period of significant discrepancy with public markets. We are monitoring this situation closely at the moment.”

Likewise, AirTree partner Craig Blair said the fund ultimately follows the valuation policy that was approved by its limited partners, and that its job was to invest for the long term.

“There’s a disconnect between the public and private markets because public markets are continuously changing, and there are many short-term investors looking to reprice things on short-term cycles,” he said.

“Our job as VCs is to think long into the future about what a start-up can become, and then work backwards in terms of valuing it in the context of today’s private market.

“What matters more than growth is the fundamentals of the business. How sustainable is the growth? Are unit economics best in class? What’s the quality of the team and culture? These will trump top-line growth any day.”

Square Peg partner Paul Bassat was also not expecting any material changes to its portfolio, saying its companies were well capitalised and not rushing to exit.

“We are highly cognisant of the sell-off in publicly listed, high-growth tech companies and this factors into our investment decisions, such as on valuations and pace of investment,” he said.

“We believe there are exceptional founders creating companies with asymmetric risk to the upside. As such we continue to believe it is an attractive time to be deploying capital in private tech markets.”

Super fund pressure

While the funds remain bullish, they all predicted fewer IPOs and Blackbird, AirTree and Square Peg, along with several other VC firms, now count several large superannuation funds such as Hostplus, HESTA, AustralianSuper, Sunsuper, TelstraSuper and Statewide Super, as investors.

An APRA review last year found in some cases unlisted asset revaluation frameworks used by superannuation funds were inadequate.

Mr Baker said Blackbird would adjust its valuation processes should the rules change and was already working closely with the super funds to ensure its policies aligned with their needs.

Public to private

David Kirk, co-founder and partner at ASX-listed Bailador Technology Investments, said the public market sell-off would inevitably flow through to private markets.

“There is a relationship between the two markets,” he said. “It’s not direct and simple and immediate, but you can understand simple arbitrage. People will start investing in less expensive markets.”

In series A and B rounds, where companies already have at least $5 million in revenue, Mr Kirk said investors considered many factors when coming to a valuation, one of which was listed comparables.

“There is tension in the whole system now,” he said. “But in reality we’re talking in many cases about possibly knocking the top off what are very successful and well-performing investments. There’s no need to panic around returns.”

Last year’s boom in valuations, he said, had in part been due to an insurgence of capital into the ecosystem from less experienced investors.

Michelle Deaker, co-founder of OneVentures, said the wall of “dry powder” on the sidelines – or VC funding – would shield Australian start-ups from a severe re-rating if they were underperforming, but only for the next 12 to 18 months.

“We are hearing that there is a readjustment coming through in those companies in the next tier [in terms of quality, i.e. lower growth rates) that may have been overpriced over the last 12 to 18 months,” she said.

“We have been in a highly unusual period where a lot of capital that wouldn’t normally be directed to asset classes like venture was prepared to take more risk to drive yield.

“With inflation and rising interest rates, there will be a shift in capital to lower risk options, and as this continues to happen, I think the valuations in the private market will start to fall.”

An early sign that some investors are getting nervous about valuations can be seen in secondary market activity, where early investors, company founders and employees can sell their stakes to new investors.

SecondQuarter Ventures chairman and Aconex co-founder Leigh Jasper said there was now more interest in locking in returns.

“In the conversations we are having where people were looking at liquidity, the fact that the market has become volatile has accelerated those discussions,” he said.

“If someone was looking at taking $1 million or $2 million off the table, now it might be $3 million or $4 million. There is appetite to sell more.”