We are often asked what impact the current stock market correction is having on startup valuations. The answer is complex.
Recently, the market prices of tech stocks have been seeing a decline. The cause of this deterioration is a chain reaction, kick started by the increase of interest rates due to inflation. This increase leads to higher discount rates, which is reflected in lower company values. An example of this progression can be seen in the Enterprise Value / Sales multiples of listed Software as a Service (SaaS) companies, which have fallen, on average, from 18 to 10 since October 2021. In addition, the observed emphasis on profitability by investors is another result of this change, leading to companies losing investments and trust if they are not growing profitably.
These developments also have an impact on the valuations of startups, although these are not exclusively negative. Scale-ups or growth startups are primarily affected by these value adjustments as their value is based on market prices, meaning we value startups that are about to be listed on the stock exchange based on comparable companies that have already been listed and take this into account in our investment decisions.
Tiger Global Management for instance in recent weeks has been renegotiating investments that had been under discussion for numerous companies, reducing the valuations.
On a positive note, the current trend is not entirely negative, as we have observed that bubbles can form around high-growth startups, which manifest themselves in falling share prices after the startups go public. Companies that listed publicly last year were down an average 32.6% since their listings through Jan. 28. This phenomenon has been noted continually in recent months and seems to be not beneficial to investor confidence. But in this respect, a certain stock market correction is useful to the market for venture capital, as it will strengthen confidence in growth companies again in the medium to long term.
While the valuations of growth startups are often based on peers listed on the stock exchange, the valuation of early-stage startups is more complex and has a greater variance. This is attributable to the weighting of indicators not yet being defined in detail. At Serpentine Ventures, we have our own methodology for valuing startups of which the market review is only one source. It is important to us to develop a versatile view based on our data. This approach takes time, in contrast to the common practice seen these days of forming investment decision in a matter of hours. However, we believe that our tactic pays off in the long run, as it allows for more balanced decision making. In this regard, we will continue to go our own way and invest in startups that other market participants consider overvalued or choose not to invest in a company because they do not meet our specific requirements.
