The S&P 500 recently posted its worst first half in 50 years, and The Fed abruptly ended a bear market rally with the Jackson Hole meeting. Startup prices, too, have plunged. Forge Global, a secondary market, has seen startup prices on its platform drop nearly 20% in February and March compared to the fourth quarter of last year.
In times like these, retail investors tend to sell first and ask questions later, and this time is no different. Venture capitalists are taking a different tack; They’re rushing to buy up depressed assets while they still can, and they’ve already raised the equivalent of two-thirds of last year’s fundraising in the first half of 2022.
The adage is true: when everyone panics, that’s usually the best time to buy. And that’s exactly what VCs are doing.
The Long-Term Outlook is Bright
In the short-term, most economists predict we’ll be entering a recession. While The Fed is attempting a “soft landing,” interest rate hikes have, historically, almost always caused a recession. Moreover, with persistent 40-year-high inflation, rate hikes may be even more painful.
Naturally, this is bad news for asset prices in the short term. A recession means reduced consumer spending, layoffs, corporate bankruptcies, and generally weak economic activity.
That said, venture capitalists have a lengthy time horizon. That’s why, even though the current market conditions may be unfavorable for startups, VCs are still bullish on the long-term prospects of the startup ecosystem.
What’s more, a downturn creates a “shake out” of great talent, which could lead to a surge in the formation of new companies. For example, the dot-com crash of the early 2000s gave birth to some of the most successful companies in recent history, including Google and Amazon.
VCs Outperform in Recessions
VCs continue to invest in the face of an impending recession isn’t just a fluke. Research by Neuberger Berman Group shows that private equity funds fared better than public markets in the dot-com bubble and the Great Financial Crisis. Moreover, stocks are more likely to face catastrophic drawdowns during recessions than private companies.
The belief that venture capital is inherently riskier than other asset classes doesn’t bear out in reality. Of course, individual startup investments are indeed incredibly risky. But when you diversify across thousands of companies, such as through a VC fund of funds, the dispersion of returns smooths out, and the risks become more manageable, to the point where VC can be a less risky investment than stocks.
The longer holding period of VC funds allows them to “ride out the storm” and wait for markets to recover. At the same time, a trillion dollars in dry powder is waiting to be deployed in the VC ecosystem, providing a major boost to startup activity in the coming years.
Another tailwind for VCs is implementing the buy-and-build strategy, which has become increasingly popular in recent years. In this strategy, VCs take the opportunity during a downturn to buy up struggling companies at a discount and then integrate them into their portfolio companies. This provides a quick shot of growth for portfolio companies and helps them consolidate their market position.
With Gridline, more investors can access these opportunities and take advantage of the potential stability VC can bring to a portfolio. Further, the SEC’s new ‘accredited investor’ definition opens up these opportunities to a wider range of investors.
VC Investment Will Continue in a Recession
In the 2008 recession, seed investing showed continued rapid growth. More recently, private equity firms posted a record $1.4 trillion in dry powder. That’s equal to 100,000 normal-sized deals. Simply put, there’s still plenty of money to go around. This is evidenced not just by continuing investments made by large VCs, such as Drive Capital and Sequoia, but also by the high number of new funds being raised.
So while the current market conditions may be tough for startups, don’t count on VC to dry up. There’s still plenty of money to be made in the startup ecosystem, even in a recession.