In response to a comment to my post earlier this week about the Profit Imperative, I rattled off some ideas about the current state of the markets. I thought it was worth sharing as a full post (I’ve edited and expanded on the original comment).
There are clearly headwinds in the markets – I’m not at all suggesting that there aren’t. And we may be in a period of strong negative pricing pressure in both the public and private markets. As you know, markets tend to perpetuate themselves and pendulum. This cycle of overreacting is how business and market cycles seem to work. Without a doubt we’re in an environment of increasing volatility and that volatility alone may spook some investors. Price shifts at the top of the market, starting with the public markets and quickly spreading to the public market investors who had been dipping into the late stage private markets and continuing from there, will and are clearly changing pricing across all stages of private market financings.
I’m generally of the view that we’re not in a bubble (see my post on that from last September here). While there’s no functional definition of an asset “bubble” that people seem to agree on, let’s at least agree that they’re caused by a fundamental imbalance between the actual “value” of an asset and the way the markets are pricing that asset. We saw this clearly in the housing market when the access to cheap capital created run-away housing prices that weren’t sustainable by any historical measure of actual underlying value. We’ve certainly seen this in the public and private markets as well (for example in the 2000 crash where truly unsustainable levels of funding were driving too many bad ideas into the market and the perception of market value and future growth and profit potential was completely out of balance with reality).
I’d differentiate this from what we saw in 2008 in the private markets where prices contracted – in some cases relatively dramatically – but where there wasn’t a true bubble bursting in the way we saw in 2001. The private markets in that case were reacting to the larger trends in the public markets (the US consumer was in a painful process of shedding debt and readjusting their balance sheets after the housing bubble broke) and to a supply and demand change in the availability of capital. That so many great companies were started in this period perhaps suggests that the venture capital markets over reacted to what was taking place in the public markets (and that’s just one measure of the over-reaction).
When I look at the fundamental value of public comps, we’re already well below historical averages (and weren’t even at the top of those averages when the markets started correcting). When I see the drastic proclamations of arageddon I think they’re unjustified by the current actual market conditions. When I look at the US economic data I don’t see anything justifying the wide sell-off in the market. When I see companies announce 1-time tax hits and drop 40% of their value overnight, I see a market that’s overreacting.
There is clearly plenty of negative sentiment in the marketplace and this sentiment tends to be self fulfilling – we will see a contraction at Series A and (especially in my mind) at Series B. Capital will retreat, companies will have a harder time raising money and pricing will adjust (however to be clear, the rise of seed rounds in the past year is nothing like the overfunding of Series A and B that we saw in 99′ – and some might argue is good for the overall ecosystem as more ideas get enough legs to test whether they have merit and those that do go on to raise their A rounds). This is a bit of an oversimplification but to some extent we live in a bifurcated world. There’s a big difference in market behavior at the high end of the markets where there has been a “bubble” around so called unicorn companies who were chasing that billion dollar valuation. This led to aggressive valuations, to aggressive terms and to aggressive expectations on growth that I think are about to come home to roost in that market segment. But to be clear, I thought this long ago and well before the public markets started reacting.
Which all leads me back to my most important business mantra:
1) don’t panic
2) gather information
3) make informed decisions
As always, the order here matters a lot.