To mark down or not: That’s the question VCs face as market slump persists
Last summer, the Swedish buy now, pay later lender was valued at $45.6 billion. But the winds have shifted dramatically since then. The most valuable private company in Europe is reportedly raising a new round of financing at a valuation of $6.5 billion—a drop of more than 85%.
While other startups may not be as affected by current market conditions as the buy now, pay later companies, investors can’t simply dismiss Klarna’s potential down round as an anomaly.
There is little doubt that a great many other startups, especially late-stage ones, would have a hard time raising capital at the valuations they once fetched. And since investors often say that an asset is only worth what somebody is willing to pay for it, many startups seem blatantly overvalued even if they won’t seek fresh capital for a while.
“Never has previous round valuations felt more stale and inconsistent with the current market,” tweeted Eric Paley, a co-founding partner at Founder Collective, a seed-stage VC firm.
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The question that many VCs are now struggling with is what, if anything, they should do about it. One answer is to mark down portfolio companies to reflect what they may be worth now.
But that’s far from straightforward.
Although all US venture firms are required to review valuations every quarter—a process called marking-to-market—they don’t all share the same philosophy on how and when an asset should be written up or down.
Micah Rosenbloom, another co-founding partner at Founder Collective, says there are three schools of thought on quarterly marks.
The traditional methodology is to value startups at what the most recent round of financing determined them to be, unless the company is severely impaired; for instance, if it were to lose key customers.
A more conservative approach is to hold the valuation at the last price the VC firm paid. The reasoning behind this method is that it is the value the investor “believed in,” Rosenbloom said.
Lastly, some VCs choose to mark down their assets aggressively when something in their particular market or the macroeconomic environment changes drastically.
There is a strong argument that the current conditions call for applying the last approach.
“If you’re going to take some hits to your marks, now is the time to do it,” said Morgan Flager, a managing partner with Silverton Partners. “If you price [companies] where they should be, there will be more upside in the future.”
That’s because limited partners are expecting losses now anyway. One LP said the net asset value of their VC portfolio dropped about 4% in Q1, and he predicts a further 16% decline.
For now, venture capitalists are more open to writing down later-stage companies because they can compare their revenue multiples to publicly traded equivalents. The revenues of seed and Series A startups are too small to be subject to that valuation methodology, many investors say.
“The earlier [stage] you go, it’s like a submarine in the ocean that doesn’t feel the waves at the surface,” said Chris Douvos, a managing director at Ahoy Capital, which invests in funds and startups.
But while it’s true that early-stage companies are years away from an exit, they have not exactly been sheltered from the market’s storms. Many new seed and Series A deals are now valuing startups at about 50% less than last year.
Since few market observers expect pandemic-era economic conditions to return, now may not be the time to keep up the charade that private companies are still worth as much as they were last year.
VCs should feel no shame in marking down the values of startups. In fact, lower valuations may help some LPs deal with their denominator effect issues—which occur when public equities plummet, forcing private asset allocations beyond their funds’ mandates—and ultimately drive more capital into VC.
Even the legendary Benchmark investor Bill Gurley recently urged investors in a tweet: “Forget those prices happened.”
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