How will this new era of inflation affect a technopreneur’s ability to raise early stage venture capital and the valuation at which they raise, given that many listed tech stocks have lost significant value since the beginning of the year, and that inflation continues to rise and appears to be here to stay.

The Economist of 29 January stated that the “era of free money is coming to an end”. Since then, inflation increased to 7.9% in the US last month, and is projected to reach 8% in the UK by next month. The inflationary outlook is not promising with oil and gas prices increasing as a result of the Ukrainian war providing further upward pressure.

Rob Moffat, Partner at venture capital firm Balderton Capital, gives some examples of dismal performances in listed Fintech stocks this year in his article at the end of January:

• Adyen stock is down 28% in the last month as I write this and its market cap of $52B is only slightly higher than Checkout’s recent private round at $40B.
• Robinhood is down 33% in last month and 66% in the last year. Its market cap is now $10B. For reference Trade Republic raised from Sequoia at a $5.3B valuation on AUM of $6B, less than 10% of the AUM at Robinhood.
• Lemonade is down 27% in last month and 68% on last year, now at $1.7B market cap. Root insurance is down 48% in last month and 92% (!) in last year, valued at $400M.

How long will it take for the public market revaluation to affect the private market?

Don Butler is managing director at Thomvest Ventures and has been in venture for more than two decades. Historically, there has always been a longer lag in the private market’s reaction to a public market slowdown, he said. In 2008-09, it took the private markets about six to nine months to react to what happened on Wall Street, he said.

A Crunchbase article  “Are The Good Times Over? Startup Valuations Dip as Inflation, Geopolitical Issues And Pandemic Concerns Swirl” of March 3 suggests that the private market is reacting much quicker to the public market revaluations this time than in 2008-2009.

However, I believe that it is too early to determine this. What is clear is that there will be a “trickle down” effect based on investment stage – starting with Pre-IPO capital raises, moving to Private Equity (PE) activity, and then growth stage (Series C,D) and finally to early stage (Seed and Series A,B) during 2022.

I was speaking with a PE executive last week who said that she was already seeing more flexibility around deal-making and structuring based on what is happening in the public markets. PE investors who are looking for an exit on public markets have to factor in their projected ROI based on these lower valuations, putting pressure on their buy-side valuations. This will work its way down to early stage investors who are also looking at their projected ROI based on exit scenarios.

Are the fundamentals in the tech economy still there?

Software/tech is still eating the world. The improvements in productivity are adding value to businesses and consumers in the real economy. The “Covid19 effect” has accelerated the adoption of technology, and the digitisation of organisations – some say by years. Whilst valuations were buoyed by the zero inflation era, the tech economy is based on solid fundamentals – a crash is therefore not on the horizon.

How will this affect the way investors in private markets look at investment opportunities?

During inflationary periods, investors are challenged to make real returns above inflation. What may have been a 10% annualised return in normal times, drops to 2% annualised real return when inflation is at 8%. This challenges investors to find investments and sectors that can drive more meaningful returns, while absorbing inflationary pressures.

It is likely that investors will become more risk averse when selecting investments. I expect that there will be a change of attitude from “revenue growth at all costs” to more emphasis on the path to profitability, burn rates and runway. Capital efficiency of funding to date will become more important.

Tech startups that have strong IP and product demand can pass inflationary pricing along to customers in order to preserve margins and real revenues. The companies that can vary pricing based on inflationary forces won’t have the margin pressures from their cost of goods, compared with companies with long-term fixed income streams with multi-year fixed price contracts.

The Crunchbase article makes the point that during this time of transition we may see more non-priced capital raises, typically Convertible Loan Notes with valuations based on a future round or event. Our experience is that these transactions have become more common this year, especially when there is a mismatch between technopreneur’s and investor’s valuation expectations.

The technopreneur that has a solid business and investment proposition should not be too concerned about their ability to raise capital in this new age of inflation. They should concentrate on capital efficiency and refocus the business towards a path to profitability. The business plan presented to investors should be moderated to show breakeven at least within a couple of years whilst still continuing with strong growth (avoiding showing higher growth at the cost of not getting to breakeven). There may also need to be more realism on valuations in the coming months, although there should continue to be plenty of private capital around for the foreseeable future.