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Alan's Thinking Cap | Q2 2023 Capital Markets Update

Jul 31, 2023

In this webinar, Ian Sigalow, Co-Founder & Managing Partner at Greycroft and EisnerAmper Managing Director of Capital Markets Alan Wink covered key market trends and an analysis of investment strategies and emerging opportunities.


Alan Wink:Good day everybody. My name is Alan Wink, managing director at Capital Markets for EisnerAmper. And I'm happy to be joined today by Ian Sigalow, a general partner with Greycroft Partners. And Ian and I are going to be discussing the state of the venture capital markets for the first six months of 2023, and a special focus on Q2. Ian, great to have you, and thanks for participating.

Ian Sigalow:Alan, thanks for having me.

Alan Wink:Let's get right into it. For the people in the webinar who are not familiar with Greycroft Partners, Ian, maybe a quick elevator pitch on Greycroft, and maybe talk a little bit about the fund’s investment and exit activity so far in 2023.

Ian Sigalow:Yeah. So, the quick pitch is Greycroft's an investment firm. My partners Alan, Dan and I started the firm about 17 years ago. And today we've got just over 3 billion committed LP capital. I think our AUM number is technically almost double that amount. And we have a handful of focus areas for the firm. So, we've been specializing in software, that was kind of our original focus area dating back to 2006. And then we've added over time sustainability, consumer products. We're always looking at emerging areas in the technology landscape to invest in. We do invest from inception all the way through to IPO. So we're a lifecycle venture manager. We're based in New York and Los Angeles. And we're fortunate to have worked with a lot of terrific entrepreneurs over the course of the last 17 years.

So, you asked about 2023 investment to date in our exit. This year in terms of capital deployment has been a lot slower than 2022 and 2021. I don't have the numbers offhand, but I would guess that we're deploying 10 or $20 million a quarter, which is way off. I think our historic pacing for Greycroft was on the order of 2 to 300 million a year. So, 50 to 60 million a quarter, and we're probably tracking to roughly a third of that amount. And I think this is actually healthy in our peer group of other venture managers. Many of them haven't done a new investment since Q1 of 2022 when I go and talk to this cohort. So, you'll see it in the macro data, but venture is going through a fairly large reset. And again, I think it's healthy for the industry that that's happening. From a liquidity perspective, it's actually turning out to be a good year for us.

I think, again, macro wise, the venture liquidity has been very low generally. I don't have exact industry data, but it was on the order of 10 to 15 billion of liquidity through the first half of the year. I think the numbers were four and a half in Q1. I don't have the final print on Q2, but I would guess it was similar. But we had actually our largest exit in the history of Greycroft, which just closed in the month of July in terms of funding. But it was announced in Q2. And that was we sold a gaming company called Scopely, that we were a seed investor in over a decade ago. And our seed investment was in a note in two founders who had an idea to build casual games, originally for the Facebook platform like Zynga.

And then they migrated that to Free to Play, and ultimately Console eventually, but gaming across all platforms. So the phone, and the PC, and the PlayStation. And we sold that business to Savvy out of the Middle East for $4.9 billion. So that transaction by itself may end up being one of the largest, if not the very largest venture backed outcome for 2023. We'll see what the rest of the year brings.

Alan Wink:Well, congratulations on that exit, Ian, that sounds awesome. Let's talk a little about-

Ian Sigalow:Yeah, it was great. It makes the 10 year holding period worth it.

Alan Wink:So let's talk about the IPO market. It seems like the IPO market has really plodded along in fits and starts for the last 18 months. But recently we've seen signs of a possible uptick. We've seen three successful IPOs in the last couple of months led by Oddity Tech last month. I was reading in the Wall Street Journal, that deal was so oversubscribed. I think they had the ability to sell $10 billion of shares for a $500 million allotment. Is it turning around a little bit? Do you expect to see a more active IPO market for the remainder of '23 and heading into 24?

Ian Sigalow:I don't. I think that there are outliers, and Oddity is an outlier. So, there's a couple things happening in the background. First off, there is still massive indigestion. And venture industry took public hundreds of companies in late 2020, 2021 and then early 2022 before the Iron Curtain came down. And those companies are generally speaking trading poorly still. And they're not fully accounted for it in the public market investors mindset. So there's been a flight to larger cap and larger mid-cap software businesses. And most of the venture backed companies that are ready for IPO, are small cap and mid-cap software companies. And if you're a public equity investor, every time one of these companies goes out, you have to make a determination, am I going to sell Microsoft and Google and Amazon to buy company X?

Right now, I think that a lot of these larger investors are still holding onto those large cap positions, because they're well positioned for the AI movement, which I know we're going to talk about. And I think the exception's like an Oddity, and there's a handful of others that are coming that are similar. If you're a consumer products investor, and your universe of companies that you pick from is the Nike's and the On Runnings, and the SweetGreens, in that world, if a profitable AI driven consumer products company hits the market at the right time, it can get a lot of investor interest. But that's not the norm. These are really unusual businesses that are getting out now. So I don't think you're going to see the floodgates open and see 50 to 70 IPOs. Again, I think we're going to see 10 to 20 IPOs a year for the next 12 or 18 months.

Alan Wink:So you don't believe-

Ian Sigalow:Big companies like The Stripes that can go out anytime they want, they'll go out. But the companies that are smaller cap, I think they're going to have a really hard time.

Alan Wink:So you're not a believer in that the investor sentiment has changed from the fear of losing money to the fear of missing out? You don't agree with that, huh?

Ian Sigalow:No. FOMO is real, but I don't think we're there right now. I think there's a lot of macro risks still ahead.

Alan Wink:So, let's change topics a little bit in the area of valuations. I think you said earlier that in the year 2021, a lot of deals were done at sky high valuations, and performance over the last 18 months as has certainly not led to those, supported those valuations. In Q2 of this year, 14% of VC deals were down rounds. Do you expect to see continued declines in valuations? And is 2023 going to be the year of the down round?

Ian Sigalow:So, what we're seeing in the market. First off, let's say that 100 companies go to market. My guess is, we're only seeing rounds happen for maybe a third of those companies. So two thirds just aren't pricing at all. And then of the third that prices, as you say, like 14% are getting down rounds. I don't know about the other 86%. Mathematically they're either flat or up. But a lot of the flat rounds include structure, and warrants, and all sorts of things that may not be being picked up in this down round number. I think that has to run its course. It's an interesting dynamic, because so many companies in prior years, in 2021 and 2020, they would go out and they'd get an automatic up round. And the hit rate was really high, and the survival rate of startups was unusually high.

And some of my VC brethren have used the term mass die off, because there are a lot of venture backed companies that don't have really strong business prospects, let alone even product market fit in some places. And those companies are going to have a very hard time fundraising. And if they don't fundraise, they're going to be out of business. And I think there's a lot of businesses that have been propped up by a buoyant fundraising market, and we're going to see that happen first. Which is, a good number of companies wind down, they do a strategic sale for talent and team. And then you'll see some down rounds. Well, then you'll see the structured rounds, then down rounds, and then business as usual. But it's going to take time. We're already 18 months into the reset depending upon where you notch the start date.

Some people say it was November of '21. For us it was really April, May of '22 when the venture world really slowed down, because a lag between the public markets and the private markets. I think it's a three year journey from that point of April '22, before we get back to business as usual. So we're in '23 now. We got a lot of time to work through some of these challenges. Entrepreneurs are oftentimes focused on their business, focused on achieving the next milestone, less focused on what their company is really worth today if it had to be sold, or if they had to raise money. And so, they don't have to worry about that until they have to worry about it. And given the size of these funding rounds, many of those founders aren't going to really be focused on that for another year, or in some cases longer.

Alan Wink:So, you said in your opening comments that your activity at Greycroft, your investment activity is pretty down so far in '23. Is that because you guys are a little bit concerned with what appears to be still pretty high valuations, or you're just not seeing great entrepreneurs building businesses?

Ian Sigalow:So, neither of those things. I say that we're retooling in a way. And the way I think about this next cycle. So, the last cycle which started probably '07, '08, was driven by mobile phone penetration, Smartphone penetration, and it was driven by the cloud. And those two technologies in our core software strategy were responsible for the outliers like Venmo. There would have been no Venmo if not for massive iPhone and Smartphone penetration, because there was already PayPal. And PayPal was perfectly fine for desktop. And the same thing is true for a game company like Scopely. There were plenty of legacy game publishers. But when you have a new format that comes out, you can piggyback on that format and grow really fast. And I can point to many companies that had a similar growth pattern. And the same is true with cloud computing.

They are successful software companies, wouldn't be successful on-prem company. They're successful because they built for the cloud and there was a migration. The next migration in our view is AI driven first and foremost, that's the technology that everyone is building for today. And I believe there will be a platform that succeeds the mobile phone as kind of everyone's everyday compute device. I'm not sure if it's going to be Apple's, what do they call it, spatial computing platform with the VisionPro, or if it will be something else. But that will come too, and it will probably come in the next three to five years. So it's time to start thinking about where that will be and how to build for it. It may be the watch. I mean, it's got amazing penetration, and I don't know what the killer app is today for the Apple Watch aside from Strava, which I use religiously.

But these are the things that we're now thinking about. And it's taking a lot of time together with the partnership, focused on what this means, where the winners will... What they're going to look like. Does AI benefit incumbents more than new companies? If it does benefit new companies, what are those new companies doing that's different. And exploring this area together, getting smart fast so that we have a prepared mind, that retooling takes time. It's not like a light switch. And truthfully, the entrepreneurs are also retooling. Most entrepreneurs two years ago didn't have a front row seat to the LLM model revolution, and the convergence of all of these models and what that means for their business. So they're now eyes as big as saucers like, oh my god, with this technology I can do all of these things. It's really exciting, but it takes time to go from idea, to building a team, to launching a break. So we're watching all of this stuff happen and being choosy with where we play.

Alan Wink:I think Greycroft is a really significant VC player around the country, especially here in New York. And you guys must see deals constantly. What gets you excited when you see a new opportunity from an entrepreneur?

Ian Sigalow:Well, the entrepreneur gets me excited. And it's always, this is the truth of our business, but, we bet on people, and they have a spark. Somebody walks into your office and they have a passion for a space, but they also have a unique insight about the way they see the world, their background, how this technology is going to change people's lives, shape the culture of the country, really big ideas. And that's where everything starts. They're good storytellers, generally speaking they're good fundraisers. But they're also good at building teams and getting people to follow them. And the venture world is always looking for that spark. And so when we find it, we fund it. Ideally we can be the very first investor with that founder, and sometimes we're a very late investor with that founder.

But that's where really the returns in the venture world in my opinion, come from. It's like betting on exceptional talent and their ability to change the world. I'd say beyond that, being in the right markets and focused on the right technical trends. There are great entrepreneurs working on projects that may be 15 years away from commercial reality. And that's one of the hard parts of our job is, figuring out when technology is ready for mass commercial adoption, and when it's not. And I can tell you a quick story about this. Many years ago, probably 10 years ago, a friend of mine at a large Sandhill Venture Fund introduced me to this charismatic founder. And the founder had an idea, "We're going to take pictures of receipts, and then I'm going to go build a retail media network. I'm going to go to the big CPGs and get them to pay me for the data, and build a loyalty network around taking pictures of receipts."

And the only problem was that it cost about 10 cents per receipt to get a human to read it, so that you could get a high match rate and accurate OCR. Because receipts are really challenging to read and scale, because every merchant has a different type of receipt, and oftentimes it's illegible, and it's folded and it is really complicated. And that company ultimately didn't work. It was built for the iPhone, but it didn't work because they couldn't get the receipt processing done right. And many years later, I met a founder in Madison, Wisconsin who had the same idea. But he had figured out how to process receipts on the phone, and do it in real time with the same error rate better now than a human.

And that technology then scaled, and now that business is called Fetch Rewards, and they last raised capital at a $3 billion valuation. So, the art of the possible, people can dream about these things, but you also have to understand what technology is required to execute on that vision. And these old ideas, many of them are now possible for the first time. And there will be other ideas I'm sure, that were tried 10 years ago that are going to be huge dynamic big businesses, because of just the way AI and technology has moved forward over time.

Alan Wink:So before we talk about AI, I'm going to put you on the spot a second, Ian. You've had, I think everyone would say, a very successful career in venture capital. What's the deal that you missed out on, that you saw early and for some reason you passed? There's got to be one.

Ian Sigalow:There were a bunch. We looked at the series A round of Twitter when it was worth probably... I think the round was 6 on 18 pre, and we didn't do it. But even that one, I think the biggest honestly was probably this company called The Trade Desk. And through multiple sources we were introduced to the CEO. That company raised a pre-seed round that I think was a $1 million dollars on 3 pre. And it's a $40 billion market cap public company 10 years later. And it was our deal to do. It was pre-revenue and very early, and in a space we knew well. But two things, one is at that time period, Greycroft also wasn't investing in pre-revenue companies. Our original formulation was that we don't do seed, we kind of do Series A.

We changed all of that 12 years ago. But for the first five years of the firm's life, that was kind of printed on the wall. And part of the reason we changed is, because we missed so many interesting businesses in that formative period where this team is exceptional, and this is an interesting idea, but it just hasn't launched yet. And what would end up happening is, other venture firms would inevitably do those rounds, and then it would end up on a different trajectory. Sometimes when the rocket ships, when the road diverges, you can never catch it again. Because it goes on to be worth a whole lot of money very fast. And we saw that continue to happen. We said, "Yeah, this isn't good. We have to change the way that we operate."

Alan Wink:So, let's talk about the AI space for a moment. Is Greycroft as bullish on AI as the media is? Where do you see the opportunities for your fund? And are valuations at a level in the AI space where you might consider investing?

Ian Sigalow:We may be more bullish than the media. Because the media has to write both sides of the story, and they tend to be middle of the road. And I'm certainly like, far more AI is coming and it's going to change everything. Yes, we're investing in AI, and yes, the valuations make sense too, if you believe that the trajectory of these companies is going to be hundreds of millions of dollars of revenue in the next five to seven years. And , and there are certain companies that are on that type of trajectory. It's kind of fascinating. Because you look at so many areas of the economy, and in particular legal and accounting and a lot of professional services roles are going to be heavily augmented by AI.

And I'm not 100% sure what the business model will be. I don't know yet how firms are going to adopt this technology, if it replaces, or substitutes, or augments. But I know that it's going to be a part of every one of our lives. It is undoubtable in my mind that we're going to have a copilot. Again, every professional, because you sit in front of effectively a super computer all day, and somewhere there's going to be an AI copilot that dramatically increases productivity. And if that comes to pass... Because productivity in the United States has been relatively stagnant for a very long time, you look at the economic data.

And if this is a major productivity unlock, it has huge implications for GDP, and for purchasing power, and for our quality of life. There's just so much that comes from that, and I'm excited for that future. I think it's going to be really interesting, and it will change education. Other areas that are hard to invest in, we're now looking at for the first and like, "Wow, what does it mean if everybody gets a tutor, and that tutor can teach your child anything?" It's really going to be interesting.

Alan Wink:So how about AI in the healthcare space? Are you guys looking at medical technologies also?

Ian Sigalow:We have. So, specifically we invested a long time ago in a company called Chiron that is going after mammography as their first use case. They were profiled in the New York Times recently. And we have another company in Austin, Texas called ClosedLoop that the Federal Government center for Medicare and Medicaid, abbreviated CMS, had their version of, I call it their Manhattan Project moment. But they had a $1 million dollar prize for AI in healthcare to create explainable AI, that could help doctors in the treatment, and the predictions and the forecasting about what's going to happen to this patient over time? And our company ClosedLoop won that prize. So we've been dabbling in AI and healthcare.

It will come for the healthcare industry. There will likely be many battles fought, because the industry is... The more regulated your industry is, the harder it is in the near term to disrupt. But then once you break through, the disruption happens very fast. They look at the Taxi and Limousine Commission and the medallion prices in New York, and it took a while, but once Uber broke through, it broke. Because all that regulation sustains things that are not economically viable for a long period of time. So, once the dam starts cracking, the water just goes right through. And I think in healthcare you're going to see this.

And many physicians today...A couple of my friends from college have gone on to become radiologists. They're dividing into groups where I think the younger practitioners are adopting AI at a faster rate. Because I've got 30 years in my career left, and I want to be on the forefront of this. Because if I'm good at using these tools, I will become so proficient and it will enable me to earn a lot for the next few decades. And they're also thinking about just the welfare of their patients. Like, having a second read from a super computer that's been trained on every mammogram in the history of time, like wouldn't that drive better outcomes just obviously? So anyway, these are the big things that we're thinking about.

Alan Wink:So let's just finish up with the topic of exits. And I know Greycroft had a special exit this year. But I guess, exit events for VC-backed companies have really been abysmal in the first six months of the year. And I do have data for the first six months, and there were only $9 billion of exits, and not a very nice number. So you know, you guys are having a difficult time returning capital, LPs getting returns for your funds. How's the VC industry going to handle this? Are exits going to come back soon?

Ian Sigalow:Well, that's really remarkable, because Scopely was 4.9 out of 9. That's amazing. And we had other companies. We sold a company called Static Media in Novacap. I've never contemplated that Greycroft would be over 50% of the entire venture industry's exit logos. But it shows you our business is really tricky as an asset class. Because there are so many venture managers that do so many different things. I think that if you look at venture as an asset class, it is probably going to have a very tricky 18 months. But I think that there will be a number of great companies that get bought, and still get out and drive returns for a handful of managers. And obviously my goal is someone running a venture firm, is to make sure that we continue to drive exits and liquidity for our LPs as hard as the market is.

And I think that the green shoots here are, one, that private equity has a lot of dry powder. And we're starting to see private equity come into the market and buy a handful of software companies in particular. And then second, the secondary market is also really well capitalized and standing at the ready. So once we have valuations fully reset, and the GP marks come down, I would expect to see increased activity there too. And those two factors, because private equity historically was a very significant percentage of venture liquidity, and private equity backed companies. I think that will help with a soft landing while we wait for the IPO to reopen, IPO-

Alan Wink:So maybe I misspoke. There were $9 billion of IPOs, $12 billion of exits. So maybe you're not over 50%, but you're certainly approaching a majority of the market. So, great news for you guys. Ian, this was a great discussion. I can't thank you enough for joining us. 30 minutes goes by really quickly. So unfortunately we don't have a chance to answer audience questions during this webinar, but we do see the questions in the chat, and we'll get back to you with answers offline as quickly as we can. So I just want to pass this back to Bella for closing comments.

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Alan Wink

Mr. Wink assists clients with capital budgeting, capital structuring and capital sourcing. He has worked with many tech and life science companies on developing the appropriate capital structure for their position in the business life cycle.

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