The last few years have seen unprecedented market volatility. 2020 saw the fastest stock market decline in history, followed by the fastest economic recovery ever, with 2021 surpassing even pre-pandemic economic growth. In 2022, the tables turned again, with the Fed turning off the ‘free money’ faucet.
Despite this turbulence, a survey of 400 middle-market U.S. CEOs, CFOs, and private equity Principals revealed that 84% expected 2023 valuations to increase or remain stable. While high inflation can shock consumer markets, businesses have managed to achieve record-breaking earnings, passing on the cost of higher prices to their customers.
The survey also revealed that a healthy majority of executives expect performance at their companies to increase year-over-year in 2023. In other words, although a recession in 2023 is likely, private companies are feeling bullish about their prospects.
In recessionary environments, retail investors, despite all financial wisdom saying to ‘buy and hold,’ sell their stocks at a low price point. Private market investors, however, aren’t following the crowd. In fact, they’re doing the opposite, pumping billions into discounted buying opportunities. Here’s why.
Private Market Investors Have a Longer Time Horizon
Retail investors can’t always be blamed for selling in a recession, as they often have a much shorter time horizon than institutional investors, like VCs. For instance, a 60-year-old investor may be about to start making retirement withdrawals. In that case, selling could be a way to protect their hard-earned capital, provided that they would sell soon anyway.
In contrast, the time horizon of a venture capitalist isn’t tied to any personal metrics. It’s not about saving for a house, a college fund, or even retirement, but rather about investing in early-stage startups with the potential to get acquired or listed on the stock market.
This goal means that a temporary dip in valuations, as we’re seeing now, is not a cause for concern. If the startup is fundamentally sound and has the capital to survive the recession, this is an opportunity to buy additional shares below the actual value.
Venture capitalists demonstrate this phenomenon today by finding buying opportunities, even in economic uncertainty.
Private Market Investors Are Finding Buying Opportunities
While so-called “blue chip” assets have fared the market downturn relatively well, the valuations of AI, FinTech, and data companies have dropped precipitously.
For instance, the AI-powered lending application, Upstart, has seen its stock price drop 90% from its highs, while PayPal, Affirm, and Nu Holdings have all seen similarly brutal stock market declines.
What these assets have in common, however, is that they’re public market assets traded on the stock exchange. Historically, public market assets have fared significantly worse in downturns and with slower recoveries than private market assets.
Venture capitalists are taking advantage of this fact and are doubling down on private markets. Although investments and exits fell in 2022, VCs raised a record $162 billion.
Tech Has a Bright Long-Term Outlook
The valuations of “risky” companies have been punished more than most in this recent market correction, but that’s not the whole story. These companies, while volatile, also have a bright future ahead.
Even Warren Buffett, who isn’t known for his high-tech investments, has invested in Nu Holdings, a neo-bank using machine learning for risk management, credit underwriting, and more. And Buffett should know. After all, Berkshire Hathaway, his holding company, made $10 billion in investments in discounted assets during the financial crisis.
It’s easy to be fixated on short-term market movements, but it’s important to remember that, in the long run, it’s the underlying fundamentals that matter most. After all, we’re in the midst of a paradigm shift. Just as the industrial revolution led to the rise of new technologies and industries, we’re now in the midst of a digital revolution. Further, just as the industrial revolution led to unprecedented economic growth, we can expect the same from the digital revolution.
This is why VCs are still bullish in areas like AI, data, and fintech. These are the industries that are going to dominate the future economy. This means that a short-term correction can be good, providing investment opportunities that wouldn’t be available in a more stable market.
This also cuts the wheat from the chaff. Stronger companies will survive the downturn and emerge stronger on the other side. This process of “creative destruction” is an essential part of capitalist economies, and it’s why recessions can be good for long-term growth.
So, don’t be fooled by the market noise. The future is still bright for private markets, and investors will continue to strike gold.