Lower Startup Valuations Are on the Horizon

Last week I wrote about how some of the country’s biggest asset managers are investing in startups because they simply can’t find a better alternative (and they really want one!). As a result, they’re all trying to identify and invest in the best startups before their competitors do. 

And there’s a LOT of money splashing around in the startup space. Globally, $621 billion was invested in startups last year, according to CB Insights. That doesn’t include the more than $456 million invested in startups by crowdfunders.

Adam Sharp has written plenty about how all of this cash floating around in the private markets has driven up startup valuations. And because the ultimate goal of investing is to buy low and sell high (rather than buy high and sell higher), there are fewer startups worth investing in right now.

But that dynamic is starting to change. In 2021, about two-thirds of companies that went public through a traditional IPO saw their share prices trading below the IPO price by the end of the year, according to research by PwC. 

Stock investors are not impressed with the performance or outlooks of these companies. And that’s not a good thing for startup investors who bought shares at higher valuations a year or two before the companies went public. Many of those investors are underwater right now. And they can’t be happy about it.

Fortunately, people who invest in startups at earlier stages are still doing well even when the stock trades below its IPO price. That’s because they take on more risk to get a better price before the startups prove themselves. But even early stage investors are being hurt by these crazy valuations. Thanks to all the cash floating around the private markets, early stage startups are being valued much higher than they should be. And that drives down eventual profits. The limited performance of the companies combined with the risk of investing in startups simply doesn’t justify the higher valuations that are on the market right now. But it’s the only game in town.

Fortunately, I believe that will change soon. Late stage investors will be less likely to pay higher valuations moving forward because now they know the public markets won’t support it. And that should have a trickle-down effect. Valuations at all stages will start to drop as late stage prices become more reasonable.

It will take some time for this to happen. There’s still a ton of private money floating around. And investors are still pushing hard to land the deals they really want. But the long-term prognosis is good. And some bargains are starting to appear. We’ll keep an eye out for them and let you know if we spot any.