State of the Markets
UNPRECEDENTED TIMESThe global economy has rapidly deteriorated, and the tech ecosystem is bracing for impact. Loss-making companies with limited runway are at risk of failure—volatility reigns.
There are two reassuring caveats: first, the VC ecosystem has weathered recessions before, and tech tends to enjoy a strong relative performance during the recovery. This will be especially true in segments with direct relevance to the pandemic, such as remote collaboration software and healthtech. Second, many of the trends that seem to be emerging predate it. Examples here include the decline of growth-at-all-costs and supply chain shifts.
The innovators we serve remain adaptable and optimistic, but also realistic. We are in for a pullback, and SVB will lead the way out.
As COVID-19 spreads across the globe, markets have fallen fast and growth has come to a halt. The market decline has been steeper than any before, reaching bear market territory in less than a month —marking the worst first quarter in history. Economists have slashed growth projections as businesses close and employees are laid off. Tech has weathered the storm well —even benefiting from policies like shelter-in-place. When we do enter recovery, tech should benefit from structural changes such as remote work, accelerated cloud demand and more.
March Sees Global Fiscal Surge
As economic activity has slowed amidst COVID-19’s international spread, many governments have introduced significant fiscal stimulus.
As fiscal positions have worsened, countries have seen their sovereign debt yields increase as investors have fled to safer U.S. Treasuries.
This is in spite of the dire consequences that the $2T U.S. package may have on the federal budget deficit. As the package includes loan programs, some of this spending will be recouped in future years.
Monetary Policy Pushes the Limit
Major central banks have taken bold and decisive action to prop up the economy, ramping up asset purchasing and adding new types of securities to their balance sheets, such as corporate bonds and nonfinancial commercial paper. The ECB and BoJ have been restrained on rate cuts, as policy rates in those economies have already been negative for years.
Research has shown that monetary policy can be less effective when interest rates are already low. There is evidence, however, that it can still be effective in alleviating acute financial crises.
As the “Great Lockdown” continues, cost reductions including layoffs and furloughs are rippling through startups. Even those that have recently raised are using this as an opportunity to right size their costs. As most companies adjust to the remote working model and implement new tools and procedures to maintain productivity, fixed costs like rent begin to look discretionary. Rent alone is not a sizable cost, yet when adding insurance, utilities, perks and more, it can start to add up. Companies that help facilitate remote work, such as Zoom and Microsoft Teams, have seen tremendous growth in daily active users in 2020.
The Expansion Generation of VCs
In venture capital (VC), experience matters, especially in tougher environments. During the GFC, managers who had been active during the Dot-Com bust saw far less performance variance than those who hadn’t, suggesting a better risk-adjusted return. This could be due to well-developed firm-level investment strategies or better deal access.
Today, the majority of active VC firms has never seen a recession. This is less the case for firms that raise larger funds. More experienced firms might be more risk averse in a recessionary environment.
Venturing through Downturns
The link between public markets and VC valuations is somewhat nebulous, but the last two recessions coincided with corrections in the private markets. This time around, valuations are yet to fall meaningfully, perhaps due to larger deals already in the works closing.
We expect the late stage to take a larger hit; 38% of late stage deals involve nontraditional investors, such as asset managers and private equity firms, that have more sensitivity to public market performance. Furthermore, later stage companies are more comparable to public peers for benchmarking valuations.
Performance through Past Cycles
Companies founded per VC fund closed is a leading indicator of startup valuations and VC performance. When the companies founded per fund closed is below average, entrepreneurs hold more power, which is observed in more favorable terms and higher valuations. Since 2014, company formation has declined and the number of VC firms has increased, which gives entrepreneurs more power. We expect the current environment to put downward pressure on valuations once activity picks up, with weaker growth expectations for startups used as the rationale for the drop.
Adversity Drives Innovation
With high unemployment leading to an ample supply of talented workers, lower opportunity costs and the potential to ride the next wave of economic growth, recessions provide a great opportunity for entrepreneurs.
With unemployment reaching ~10% post-Global Financial Crisis, annual company formation reached a record high. Around 41% of today’s unicorns were founded during or in the aftermath of the GFC1. Today, 9% of the constituents of the Nasdaq were founded between 2008 and 2012.
This material including, without limitation, to the statistical information herein along with the analytical insights and anticipated impacts contained, is provided for informational purposes only. The material is based in part on information from third-party sources that we believe to be reliable but which have not been independently verified by us, and for this reason, we do not represent that the information is accurate or complete. The information should not be viewed as tax, investment, legal or other advice, nor is it to be relied on in making an investment or other decision. You should obtain relevant and specific professional advice before making any investment decision. Nothing relating to the material should be construed as a solicitation, offer or recommendation to acquire or dispose of any investment or to engage in any other transaction.
All non-SVB-named companies listed throughout this document, as represented with the various thoughts, analysis and insights shared in this document, are independent third parties and are not affiliated with SVB Financial Group.
Silicon Valley Bank is registered in England and Wales at Alphabeta, 14-18 Finsbury Square, London EC2A 1BR, UK, under No. FC029579. Silicon Valley Bank is authorized and regulated by the California Department of Business Oversight and the United States Federal Reserve Bank; authorized by the Prudential Regulation Authority with number 577295; and subject to regulation by the Financial Conduct Authority and limited regulation by the Prudential Regulation Authority. Details about the extent of our regulation by the Prudential Regulation Authority are available from us on request.
Silicon Valley Bank, a public corporation with limited liability (Aktiengesellschaft) under the laws of the US federal state of California, with registered office in Santa Clara, California, USA is registered with the California Secretary of State under No. C1175907, Chief Executive Officer (Vorstand): Gregory W. Becker, Chairman of the Board of Directors (Aufsichtsratsvorsitzender): Roger F. Dunbar.
Silicon Valley Bank Germany Branch is a branch of Silicon Valley Bank. Silicon Valley Bank Germany Branch with registered office in Frankfurt am Main is registered with the local court of Frankfurt am Main under No. HRB 112038, Branch Directors (Geschäftsleiter): Oscar C. Jazdowski, John K. Peck. Competent Supervisory Authority: Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin), Graurheindorfer Straße 108, 53117 Bonn, Germany.
Silicon Valley Bank, is an authorized foreign bank branch under the Bank Act (Canada).