The “bigger fool” theory holds that one can also profit from buying properties at an exorbitant price, as long as someone is willing to buy them in the future at a higher price. The theory explains some of what has happened in the startup market in recent years. The money that has flowed into investments in start-ups, especially since the beginning of the corona, has caused funds to pay for shares of companies, even when they knew the price was excessive – assuming someone would want to bounce back their value. It could have been the investor in the start-up’s next round of investment, or the public in an IPO.
The increase in the value of companies has done good for venture capital funds. According to research firm PitchBook, the weighted annual return (IRR) of venture capital funds between 2018 and 2021 averaged 30.5%, compared to 8.5% recorded by real estate funds and 24.1% by private equity funds. Due to the success, equity funds Risk has deviated from secrecy in the past year, revealing returns. Million million during 2018 – 2020 for those worth a billion dollars.
But recently the wheel stopped. First, through declines in technology stocks on the stock exchange, and later through declines in the value of companies in the private market. Now, the industry has entered a crisis that has manifested itself in the difficulty of raising funding, layoffs and cuts. Will the crisis cut off the fantastic returns recorded by venture capital funds?
Signs of decline in yield
Some Israeli funds managed to realize the returns of the peak years, such as Vertex, which sold holdings of $ 150 million just before the crisis, or YL Ventures, which returned $ 450 million to its investors last year from selling its stake in the Exonius and Orca Securities unicorns.
However, most of the returns recorded by the funds were not realized. According to Cambridge Associates, 2020 was the second best year for venture capital funds after 1999, the heyday of the dot.com bubble. However, 90% of the returns achieved this year remained on paper. According to PitchBook, venture capital funds hold $ 1.4 trillion in assets on paper alone.
Early signs show that the value of fund assets is starting to decline. The PitchBook report found that 68% of the sampled venture capital funds recorded a decrease in their return on money (in terms of TVPI – the present value of the investment divided by the original investment) compared to 2021. Fund yields in the first quarter of 2022 fell by a median of 3.5%, the highest since 7.8% in the crisis days of 2008. The burst of the dot.com bubble in 2000 saw a larger decline, 15.7% in the quarter.
Yanai Oron, managing partner at the Vertex Fund, estimates that we are still in the middle of the process. “I estimate that so far the decline in the return on money of venture capital funds has come mainly from a decline in the value of shares in the companies that have been issued, and the funds have not yet exercised their holdings,” Oron says. “But most of the holdings of venture capital funds are in private companies and there only a small portion of the funds have lowered the value of the companies in the books, and adjusted it to the market. This reduction in value will happen slowly, as there are really no standards on how to do it.”
While the value of public companies has a clear number derived from the market, the value of holdings in start-ups is a more subjective matter. Most often, venture capital funds record the value the company received in the last round. This has advantages in a declining market situation, where as long as companies do not raise at a new value – their previous number can be recorded in the books. In contrast, other funds will be updated The value of start-ups in books, with their competing public companies losing tens of percent of their value.
“There are funds that sit on the fence and as long as the company has not raised a down round, they do not touch the numbers listed in the books. There are also funds that will claim, with some justice, that the situation is currently unstable in the market.” Yair Snir, Managing Partner at Dell Technologies Capital. “But I think we are not in a normal period, so the funds need to give realistic reporting and proper disclosure about the true value of the companies.”
Yair Snir / Photo: PR
The truth will be revealed in years to come
The American Tiger Global Fund, one of the world’s active companies in the last two years, is a good example of the slowness in which the value of start-ups is updated downwards. In the first five months of the year, the fund recorded a 52% decrease in the value of investments in public technology shares. On the other hand, it adjusted its investments in start-ups by only 9% downwards.
Eventually, as history shows, investments made in 2020 and 2021, when prices paid for start-ups were at their peak, will prove to be particularly unprofitable and funds such as Tiger Global, which spray-painted investments in start-ups in the corona years, will suffer a decline in returns. But until the truth is clear, it could take many years.