To our Valued Investors:
The last time we took a close look at the state of public financial markets was a full month before Russia’s invasion of Ukraine accelerated a broad selloff (The Beneficial Disconnect, January 26, 2022). While that essay did point to concerns about what the future might hold for Ukraine and, similarly, Taiwan, at least as much attention went to anticipated interest rate hikes. The central message, though, was that our Second Market, the dwelling place of the private companies in which Iron Edge VC specializes, is largely shielded from the woes of public market meltdowns. Whereas the illiquidity in venture investing had often been regarded as a drawback, glacial-paced price movements are more welcome when the rest of the world is on fire. Admittedly, the purpose of the communication was to reassure our investors and potential investors that even at times when people avoid looking at their brokerage account balances, our products can provide a good source of risk mitigation. Our aim was to emphasize that we still have a good thing going.
The Dow Jones Industrial Average is currently a few hundred points higher than it was last January 26. The slight relief didn’t come in a straight line, of course; we witnessed some stomach-churning plunges along that roller coaster ride. It’s not quite time to uncork the champagne, either, despite the fact that the Dow us up more than 750 points this week alone. The same uncertainties we faced at the beginning of the year — geopolitical instability and overall economic fragility chief among them — are far from settled. It’s impossible to declare with any true measure of certainty where we are headed. If markets were predictable, after all, each one of us would be fabulously wealthy.
Because it affects a much smaller global community, the private marketplace receives only a tiny sliver of media attention in comparison to the copious reporting on the public markets. It’s our job to remain focused on whatever we can read about developments in venture capital. After all, “VC” is right there in our name. So far, the second quarter of this year has brought with it a fair amount of commentary about venture funding. Much of it has suggested, or at least speculated about, a reduction in funds directed toward startups and later-stage enterprises. Forbes noted that the onset of the covid-19 pandemic two years ago initially generated fear of an abrupt halt to private funding, but in fact “the opposite happened, and the pandemic pushed the market into one of the strongest bull periods on record”. The article then proceeded to cite unattributed “investors” in its assertion that late-stage activity “slowed considerably” in March, and that the reduction has had a ripple effect that has impacted earlier-stage funding as well. The National Venture Capital Association last week politely characterized the Q1 slowdown as a “healthy recalibration period” for dealmaking. Supporting all this, perhaps deceptively, is this year’s undeniable stalling of Initial Public Offerings (IPOs) and other means for companies to make a debut on the public markets. As of this week, 87 companies have taken the plunge this year, and none have involved household names or blockbuster volume. At the same point in 2021, 428 companies had gone public. We are behind by nearly 80% this year. It would be wrong, though, to attribute the trend to fiscally unhealthy private companies. In truth, it’s a more direct consequence of tumultuous public markets. The CBOE Volatility Index has been as high as 39 this year. The Volatility Index is also called the “VIX”, or more ominously, the “fear gauge”. It depicts levels of uncertainty in the markets. Conventionally, a VIX higher than 20 suggests that an IPO would be considered too risky. As the VIX has just begun to lightly bump into that more attractive level, early investors looking for a public exit will likely need to exercise patience for the time being. It will probably be a while before the larger investing community feels the sustained comfort of stability, and big companies with a lot of capital on the line are generally reluctant to go public in these conditions. Nobody wants to learn how to swim in the middle of a hurricane.
Tempting though it might be to conclude that the rough road for the public markets was a precursor to private market dings, we maintain our position that the two arenas are entirely unrelated. The revenue numbers at a Silicon Valley AI startup are in no way, shape, or form swayed by Russia’s atrocious advancements on Ukraine. Interest rates, of course, have an impact on all individuals and all businesses, but not enough to meaningfully obstruct venture capitalists from doing their thing. As for the aforementioned reporting on a lull in VC funding, well, numbers can be funny. Statistics can be presented in a way that tells the story that the writer wants them to tell. It is true, for instance, that the $160 billion raised in the first three months of this year represented the first quarter-to-quarter decline in a year. Nevertheless, the sum still bested 2021’s first quarter by 7%. This is less of a doomsday revelation than an ordinary end of a streak — and a short streak at that. 2021 was a record-shattering year for raising capital, and ’22 is thus far defying the odds with a better start in a much shakier economic environment.
We often refer to the lettered funding rounds that raise capital for growing businesses — “A round”, “B round”, and so on. Even for those not engaged in the study of VC funding, the concept is quite simple. Funds enter a private company’s cap table (the official ledger of registered shareholders) through these sequential rounds. Typically (but not always), as a company takes on investors while separately generating revenue, a funding round places a higher value on the company than the previous round did. This increase in a company’s valuation from one financing round to another is known as a step-up in value. The step-up is calculated as the valuation at the beginning of a round divided by the valuation before the prior round. A company with a valuation of $3 million at the first round and $9 million at the second round has realized a step-up in value of three times between these two financing rounds. A two-year study of “C” round step-ups reveals some solid, unmanipulated facts that demonstrate the strength of private growth opportunities even in the face of choppy public markets:
Note the spike in February, right when things were arguably at their worst everywhere else in the financial realm. Observe how that most recent step-up, at 2.8, is the highest on the entire chart. The illustration couldn’t be any plainer. Venture capital is not in the throes of a recession, and the public and private markets don’t have any meaningful correlation when it comes to themes of feast or famine.
It’s important to understand that we are not recommending that investors pick a private company and start placing bets. The volume of big VC checks being written is not a reliable indicator of an individual startup’s or late-stage company’s success. Sometimes the big guys make bad choices — just ask SoftBank how WeWork panned out for them. Sometimes a pre-IPO company will offer an investment into a “red-hot” name, but at a grotesquely inflated valuation. Iron Edge VC avoids these pumped-up attention grabbers like the plague as they are much less likely to deliver high-percentage returns, if any. We need to know who among the most reputable VCs are investing in a company, in how many rounds did they participate, and how big is their financial commitment. When these numbers signal a winner to us, we will do a deep dive into the company’s fundamentals, get to know the management, and then claim our own spot on the cap table. With this approach, our labor is sharply focused on providing our clients with refuge from some unforgiving public markets.
We at Iron Edge VC are proud to have access to the shares of today’s most exciting private companies that have proven and emerging track records of impressive growth, but still have tremendous potential and are not yet available on the public markets. When you buy shares in our Funds that house these exclusive investments, you will be along for the ride with us. If you would like to learn more, or if you know of anybody else who would, do not hesitate to contact us by clicking “Get in Touch” below.
If you have enjoyed this article, visit the Iron Edge Blog for past updates on our pre-IPO opportunities and for general commentary on investment in the private marketplace.
As always, shares of Iron Edge investment funds are available on a first come, first served basis.
All the Best,
Founder & Managing Partner
Founder And Managing Partner