EquityZen Users Community/Investor Experience
Market Drop Review: What Should You Do?
In this article I will consider the current situation in the venture market from the point of view of simple logic, history, and common sense. I’ll try to do without complex analytics and predictive calculations :)
What the indexes say
It is not news to anyone that the global market of investments is going through tough times. This applies both to the venture capital market in general and the secondary market in particular.
The venture capital market logically directly follows the stock market. Such benchmarks reflect the situation as S&P500, Dow Jones, NASDAQ, etc., demonstrating a critical drop in indicators (causing investors’ grizzle).
Over the first six months of the year, the S&P500 — a popular index to which many 401(k) accounts are pegged — plummeted 20.6%, marking its worst first-half performance of any year since 1970. The tech-heavy Nasdaq fell even further, dropping more than 28% over the same period; the Dow Jones Industrial average dropped more than 14%.
The situation with indexes of non-public stocks is not much better.
ARK
ARK Innovation indexes have been among the biggest losers this year.
The ARK Innovation ETF (ARKK), a proxy for riskier, speculative tech, has plunged about 59% this year. It’s more than 70% off the all-time highs it reached in February 2021.
Renaissance
The decline in the value of the Renaissance IPO ETF (so-called “IPO index”) was also significant — from $76 in December 2021 to $33 in July 2022.
The fluctuations in the prices of classic indexes show that since June 2022 we have faced a “bear market.” Without exception, all benchmarks have fallen noticeably compared to last year. The slight increase that periodically takes place has not yet allowed the positions to return to their original values.
Features of the problem
The venture capital market in 2022 looks most contrasting against the previous 2021 when there was a record number of IPOs and a sharp increase in company valuations.
Last year was a record year for IPOs, with low interest rates serving as a catalyst for nearly 400 U.S. debuts to raise over $140 billion. The 18 companies that have gone public so far in 2022 have only managed to raise a total of around $2 billion. On top of this, the performance of stocks that went public in 2021 has been lackluster — the average 2021 IPO is down over 20% from its issue price.
Renaissance Capital Research Director Nick Einhorn
Frankly, many private companies ended up to being overvalued at the end of 2021. Record valuations and unprecedented stock prices created a unique overheating situation in the market (and a collapse always follows overheating, isn’t it?).
Some resourceful investors have taken advantage of this overheating and promptly sold their shares for huge sums. Let’s wait and see whether those who bought these shares in the overheated market were winners.
The critically low number of IPOs in 2022 is primarily due to changing the SEC’s policy towards SPACs, depriving them of advantages over traditional IPOs.
This is a significant innovation as listing through SPACs jumped nearly 150% in 2021 compared to 2020. Due to the new rules of SEC, many companies have postponed their liquidity events early planned as SPAC-based.
On the other hand, many private companies have postponed their IPOs, simply because they are not worth the money they were valued at in 2021 while planning an IPO.
Fluctuations in the venture capital market are also related to the fact that there is no balance between the old valuations of companies and businesses, current valuations, and reality.
Many startups raised significant investments in preparation for IPO (which eventually did occur). Thus, investors face losses. But they do not lose optimism! According to statistics, more than half of investors expect market growth and look positively into their investments’ future.
Anyway, it is not the best of times for investors today. Assets are getting cheaper, and this process continues. In other words, the bottom has not yet been reached, and it is a big question whether the market will grow soon or not.
Most of economists expect a recession to start by the end of the year.
This is far from an outlying view. In total, 38% of economists polled by the Financial Times, are predicting the recession will occur in Q1 or Q2 of 2023 with a further 30% seeing it kicking off in Q3 or Q4 of next year.
What should you do?
Most investors are taking a wait-and-see attitude now. They wait for the market bottom to start buying back and prefer to stay on the sidelines until the bull market returns.
It’s not the time to sell at the moment. The market is not at the bottom, and shares prices continue to fall. So, they will definitely start to rise after reaching the bottom, providing much more interesting selling opportunities.
On the other hand, it’s also not the time to buy. Share prices seem to be getting MUCH lower soon, and it is imperative to notice this bottom threshold to stock up appropriately.
The venture capital market is experiencing intense volatility, which creates a lot of unpredictability for all market players. What do we see there in 2022? First of all, global instability and inflation. Instability is the main enemy of the market. The market may be on a high, on a low, or it may be in the middle position. The big thing is this situation should be stable. But the market sorely lacks this stability right now.
Against this backdrop, many investors froze in anticipation of the outcome. It was expected in the fall, but the closer to September, the more understanding that volatility may persist until the year’s end.
Do not forget that summer is the time for vacations and traditionally inactive stock market. In the fall, slight thaws are expected, and winter will be the decisive moment.
As you know, you can have any predictive expectations — the market will behave differently.
Market analysts expect the stock market to reach this point of bottoming out sometime before 2023. Past recoveries suggest market performance can suddenly flip, said Sam Stovall, the chief market strategist at research firm CFRA.
As for the future, it will undoubtedly depend on the economic situation in the world.
The future of the market will traditionally be determined by factors such as:
- the conflict in Ukraine and its consequences (prices for energy, grain, and raw materials)
- monetary policy and measures of the US Federal Reserve System
- development of the situation with COVID-19
- inflation rate
However, the market will stabilize sooner or later, which will be a good sign for investors.
It’s easy to catch positive signals from the main venture indexes and best VC’s actions.
“So I do think this [slowdown] is going to be a bit sustained. The kind of key indicator we’ll look at to see if the window will open back up a bit more is once you see some of these kind of bellwether tech names — so think of companies like Peloton (PTON), Zoom (ZM), DocuSign (DOCU) — start trading kind of back above even pre-pandemic levels to kind of show that maybe the worst is behind us”.
EquityZen Co-Founder and Chief Strategy Officer Phil Haslett
A positive note about the future
Investors who will be patient will likely have good prospects in the next 10–20 years. So, you shouldn’t pay attention to market today versus market last week versus market next week.
The growth of the market is inevitable. Immediately after it reaches the bottom, you can start waiting for positive trends.
Reid Hoffman, co-founder of LinkedIn and investor at Greylock Partners tend to be optimistic:
“Well, this is a blip, and we’ll recover.”
“PayPal is a perfect example of this because it started before the dot-com burst and then had basically no revenue, raised 100 million and 500 on a promise, that used to be huge numbers. And the next day was the NASDAQ peak and started the set and kind of navigating through it”.
No less optimistic is Jason Calacanis, entrepreneur and angel investor:
“I always tell people, fortunes are created in down markets. They’re collected in up markets. And here we go, the cycle starts again.”
Silverblatt, the analyst at S&P Dow Jones Indices, thinks all it takes in this situation is to work on getting over that moat as soon as possible. The first step is focusing on your own financial situation and circumstances.
“Investors should take into account their level of financial cushion, and thus their ability to withstand losses in the short term.”
“If you can’t live through it because you can’t take the loss, you can’t play it.”
Moreover, the current market decline does not look so catastrophic on a global scale — it is just a tiny wave inside a significant trend.
Savvy investors see that over the past 12 months (from May 2021 to May 2022), the S&P 500 is only down about 5%.
And if you pull back even further, you’ll see that the stock market is still up 64%(!) from where it was five years ago! Sixty-four percent!
“We’re buying a stock based on how much we think the company is going to make in the future”, Howard Silverblatt, a senior index analyst at S&P Dow Jones Indices, told ABC News.
“Ultimately, investors are deciding whether to buy or sell based on the likelihood that a given business will succeed over the coming months and years.”
Сompanies valuation
What companies will bring profit to investors, safely pass through the crisis and will only become more substantial, having outlived competitors?
How can investors spot promising startups among the many losing businesses in the venture market?
Against this backdrop, it’s interesting to explore companies that took a risk and openly reported they were overvalued in an era of an overheated market and then lowered their current valuation on the eve of an IPO amid a market correction.
As a result, they are ready to go public at a lower cost. They are (apparently) confident in themselves, their business’s viability, and ’its ability to bring them more value in the future than in 2021.
Is confidence a sign of the high quality and vitality of a company?
For example, look at the most sensational IPOs of 2022 — Instacart and Discord.
Both became well-known when they dropped their valuation to record lows (for example, Instacart cut its valuation by nearly 40% from $40 billion to $24 billion).
Both plan to go public before the end of 2022.
Both are confident in their future and are backed by a strong pool of investors.
A brief analysis of these companies shows they are the middle peasants. They are relatively stable businesses but lack star potential, and there are no signals of them becoming unicorns or disrupting their markets.
EquityZen Users Community will publish full reviews of these companies in special articles soon, and I’ll add links here.
UPD: You can find Instacart review here and Discord review here :)
Apparently, investing in brave and honest Pre-IPO companies isn’t the best solution.
Which companies should you pay attention to?
I have a few thoughts on this.
1. Trends and Technology
Technology and digitalisation is the primary trend of recent times, which will remain the engine of the future world, market, and civilization. Tech companies are by far the most promising!
According to Greylock, …”if you look at the next decade, almost all major growth is still going to happen through technology, whether it’s the digital revolution transformation of existing industries or by tech companies. And so, there’s still a lot of capital that wants to be investing in it. Maybe that capital would be now more focused on AI and less focused on something else. But… the industries of the future are still technological and still really matter.”
Ark Invest chief Cathie Wood believes the market is near a bottom and that tech stocks will be the first to recover.
By the way, the S&P500 index, which is expected to grow in the long term, is formed by technology companies.
According to Wells Fargo Investment Institute President Darrell Cronk, “Tech is still not just the largest sector, but it’s equivalent to the bottom five to six sectors mathematically on the [S&P] index. If you don’t get tech to participate, you’re going to have a difficult time pushing back to old highs or setting new all-time highs.”
2. Traction
Traction and key company indicators are the second highlight. If a business did not demonstrate high performance in the overheated market, “in greenhouse conditions,” there is nothing to expect from them in a crisis. The better the business performance is, the higher its viability, the more chances it has to survive!
According to Sequoia, “Investors’ focus is shifting to companies with profitability. With the cost of capital (both debt and equity) rising, the market is signaling a strong preference for companies who can generate cash today.”
Companies who move the quickest have the most runway and are most likely to avoid the death spiral.
3. New Horizons
Following A12Z, you should focus on crypto and web 3.0.
Following Tiger Global, it is worth expanding horizons and paying attention to:
- niche companies that do not depend on public analogues and develop their sphere from scratch,
and - young early-stage companies that are free from the problems of big business, such as the compelled mass layoffs, inflated valuations, and obligations to investors in a crisis,
Something else speaks in favor of this.
Some investors believe that the market drop provides the growth of new promising startups. Large companies are forced to cut some employees, including really talented ones. So, most of these laid-offs are starting their own businesses and implementing their ideas right now! That’s where the diamonds will actually be! It looks like it’s time to shift the focus from pre-IPOs to seed investments and early stages with all-star teams.
4. Diversification
Good old diversification comes to the rescue in an era of uncertainty. If you are unsure where exactly you will find profit after the crisis, try different ways.
Cathie Wood said her clients are mostly sticking with her and new money is coming in as investors seek diversification in a down market. ARKK has had more than $180 million in inflows in June, according to FactSet.
“I think the inflows are happening because our clients have been diversifying away from broad-based bench marks like the Nasdaq 100,” Wood said. “We are dedicated completely to disruptive innovation. Innovation solves problems.”
5. M&A activity
The company’s ability to merge and acquire can serve as a benchmark.
Global mergers & acquisitions (M&A) are down by 27% compared to SPAC-induced H1 2021 but up 35% compared to the average of the previous cycle (2015–19). The technology sector dominates with nearly a third of total activity.
Thus investors should look at companies that continue to absorb competitors and small players in their market or are ready for mutually beneficial support through a merger despite the crisis. Such activities signify that the business has the resources and understanding of a unique moment in the market.
As my fellow investors and me, the wait-and-see attitude dominates. The best thing to do is to keep your eyes open and closed on the situation so that you sell with a profit while at the bottom and notice and have time to buy shares of up-and-coming companies.
I hope you found this helpful! Share your current investment strategy and share this article with those who may need it now.
Wish you successful investments!
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