When Will Valuations Bottom Out? Lessons From Past Downturns

To help startups put their financing plans in context, we wanted to develop a sense for how long the current downturn in VC funding might last and how far valuations could fall. Nobody can predict the future, of course, but just because we can’t predict the future doesn’t mean that we shouldn’t learn from the past. In this instance, we wanted to see what insights past downturns might have regarding two specific questions:

· How long were past downturns (and what does this imply for this one)?

· How quickly do venture valuations reflect changes in public market valuations?

Our analysis suggests that it could be several more quarters until we reach the bottom of this downturn, and that it could take several more years until we return to the highs of 2021. We also found that venture valuations closely track public market valuations, and that they typically adjust within one to two quarters. To predict when venture valuations will have bottomed out, one need look no further than the NASDAQ Composite index as a leading indicator.

How long could this downturn last?

To learn from past downturns, we used Pitchbook, Inc. data to analyze how a various metrics including valuations, round sizes, and number of financings correlated with metrics in the public markets and the broader economy. We looked at data going back to 1995 to include data around both the popping of the Internet bubble in 2000-2001 and the Global Financial Crisis (GFC) in 2008-2009.

The data from the popping of the Internet bubble was frankly bleaker: valuations did not recover to their pre-bubble highs before the 2009 downturn drove them further down eight years later. However, the data from the GFC downturn is much more interesting. In that downturn, it took 1.5 years for venture valuations to reach the bottom and another 2.25 years to climb by up to the pre-crash highs. To put that in perspective, the full cycle to return to pre-crash levels in venture (across multiple metrics) took almost four years.

How long did valuations take to recover after the Global Financial Crisis?

Given the incredible ramp up in valuations in 2021, we would not be surprised to take this cycle to even longer to recover to their 2021 highs.

The question this begs for startups is where in the cycle will they be raising? Companies that have decided to push their next fundraise out until early next year would ironically find themselves raising near the bottom of the cycle if this downturn is history comes close to repeating itself.

How quickly do venture valuations reflect changes in public market valuations?

The second question we had was how long it takes for venture valuations to reflect changes in the public markets. To analyze this, we looked at the correlation (r squared) between pre-money valuations and the NASDAQ Composite Index.

Series A Pre-Money Valuations vs. NASDAQ Composite Index

The strongest correlations are after a one-quarter delay across Series A, B, and C rounds. The degree of correlation is remarkable. It surprised us, and it shows just how much the venture and entrepreneurial communities really look to public markets as the barometers of value.

The other surprise here was that the strength of the correlations was the inverse of what we expected. We expected that later stage company valuations would more closely track public markets given that these companies are closer to an exit via either an IPO or an acquisition. Instead, the correlations were strongest for earlier-stage companies rather than later-stage companies.

In reflecting on why the correlations might be stronger at earlier stages, a few factors come to mind. The average later-stage company typically has more scale and thus it could be that these companies are able to cut back expenses and use their greater revenue scale to support their companies longer, thus deferring the need to raise another round.

It could also be that the investors in these companies are willing to support their prior valuations, whether that be through debt financing or other means. We’ve also seen that later stage companies typically have larger syndicates that could make valuations relatively more “sticky” for these companies given the various dynamics at work among syndicate partners. All these dynamics are typically missing or significantly lessened at the Series A, and thus it seems that companies at earlier stages see valuations changes that are more strongly track changes the public markets.

Implications for Entrepreneurs

While no one can predict how long or how much further the markets will fall, the observations from prior downturns show us that downward trends in venture can last years. Given how strong the run-up in valuations were in 2021, it would not surprise us if we did not reach bottom for at least a few more quarters. Given how closely venture metrics have tracked NASDAQ Composite, we’ll also be following this metric as a leading indicator for when the venture market will begin its rebound.

As investors, we’ve shifted our focus to companies with better unit economics and lower burn rates, even if that comes at the expense of higher growth. Investors now value the quality of revenue growth in a way that they didn’t just a few quarters ago. The focus on efficiency of growth also typically extends runway and thus buys more time for the market to settle into a new equilibrium around valuations. Downturns offer the opportunity – even if painful – to become much stronger in the long run.

Though valuations are coming down, we continue to be active in making new investments and we are also encouraged by the number of new funds that are being raised among our peers. One difference from past downturns is that we now have innovative financing options, such as revenue-based financing from companies like Capchase (a Thomvest portfolio company), available to startups. Options such as these as well as our own experience imply that while there is a valuation reset underway, we continue to see a vibrant funding environment for entrepreneurs, particularly if they have built companies that can combine operational efficiency with revenue growth.