Why some VCs are hopeful of a pullback in sky-high valuations
Tech stocks have been flashing red on and off for over a month amid investor anticipation of aggressive interest rate hikes by the US Federal Reserve. Shares of many closely followed stocks like Zoom, Peloton and Robinhood have given up more than 50% since their peaks in 2021.
Yet founders continue to pitch venture capitalists and successfully close funding rounds at sky-high valuations. Software startups are still fetching valuations at or significantly above 100 times their annualized revenue, despite public SaaS companies trading many times below these levels, according to Tomasz Tunguz, a managing director at Redpoint Ventures who writes a widely read SaaS-focused, data-driven blog.
Some venture capitalists say new venture deals can start pricing at meaningfully lower valuations only after the stock market remains depressed for a sustained period.
And they are hopeful that this will take place.
“I think many investors would welcome a decline in valuations because things seem much more exuberant than they ever have in the past,” said Lisa Wu, a partner with Norwest Venture Partners.
Wu said that while she currently does not see any deal pricing decline, she believes a reset is coming.
While VCs have been saying for years that startup prices are overheating, valuations jumped more dramatically last year than in any other year since at least the middle of the previous decade. In 2021, the median late-stage VC valuation in the US was about 20x revenue, nearly doubling from a 10.9x multiple in 2020, according to PitchBook data.
Private market valuations have shot up over the last year in large part because of a capital influx from crossover investors such as Tiger Global, who have offered to pay more for deals than traditional venture investors. Many VCs have adjusted to increased competition by writing larger checks at increasingly higher valuations and investing in earlier-stage startups.
“If interest rates start to go up, I certainly think valuations should respond and come down,” said an LP of a prominent university endowment who asked not to be named. “And if valuations come down, presumably that will lower the size of rounds, and the frenetic level of activity will slow down. It wouldn’t be bad to have a little bit of a retrenchment.”
This LP expressed concern that the current venture market has become so overheated that some investors could be taking on too much risk by pouring massive amounts of capital into companies that may never become profitable.
Cameron Stanfill, a VC analyst at PitchBook, said that tech stock dips could prompt private-market investors to be more conservative in pricing pre-IPO funding rounds.
“I think there is a significant chance that public company multiples are normalizing back to the mean of the last couple years,” Stanfill said.
Because the VC ecosystem is so flush with newly raised capital, startup founders are unlikely to feel pressure to accept new investments at lower prices, Stanfill said. Last year US venture capitalists raised a record of almost $130 billion in new funds and have already added nearly $13 billion to their coffers in the first week of this year, according to PitchBook data.
A drop in valuations is always a double-edged sword for VCs. Investors prefer to pay lower prices on new deals, but they also want their portfolio companies to be marked up by other investors in subsequent rounds.
Yet some VCs whose still-locked-up public companies have cratered on the stock exchanges are still looking forward to share price declines eventually trickling down to the private markets.
“As much as it pains me that a bunch of our companies that recently went public are adversely affected just like other tech stocks, I think what is happening in public markets is ultimately healthy for the venture ecosystem,” said Ravi Viswanathan, founder and managing partner of NewView Capital, a growth-stage investment firm which spun out of NEA in 2018.
Valuations in new funding rounds will start pulling back if tech stocks continue to trade at lower levels for a couple more quarters, Viswanathan said, adding, “We actually need to let the air out of the tires once in a while.”
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