Alan's Thinking Cap | Q4 Capital Markets Update
- Jan 25, 2024
- Alan Wink
- Tom Wisniewski
The 2023 venture capital market can be described by one word: “Challenging.” It is challenging for founders looking for capital; VCs looking for exits, and VCs looking to fundraise. Valuations continue to decrease and have not yet showed signs of a rebound.
In this webinar, Tom Wisniewski, Managing Partner of Newark Venture Partners and EisnerAmper Managing Director of Capital Markets Alan Wink as they give a 30-minute Q4 2023 capital markets update covering key market trends and an analysis of investment strategies and emerging opportunities.
Alan Wink: Good day everyone, and welcome to the Q4 Venture Capital Update. Each quarter we try to get some perspective on the state of the venture capital market from a different venture capitalist in different geographies around the country and in focus on different sectors of the tech ecosystem. This quarter, it's my pleasure to be joined by Tom Wisniewski, the managing partner of Newark Venture Partners, a pre-seed and seed stage investor based in Newark. Tom, welcome and we look forward to hearing your comments.
Tom Wisniewski: Great to be here. Al. Good to see you and everyone else.
Alan Wink: Thanks Tom. I remember being at the press conference in Newark about eight years ago when the formation of Newark Venture Partners was announced. You've attracted quite an attractive and interesting group of limited partners, including Amazon, to invest in your fund. Can you talk a little bit about the history of the fund and also how it came to be located in Newark?
Tom Wisniewski: Yeah. Yeah, it's great. So our inception story. So about eight years ago, I was introduced to the founder of Audible, Don Katz, Audible part of Amazon, and his headquartered in Newark, New Jersey. And he's very passionate about the tech ecosystem and very passionate about the power of technology companies in economic development and a really grand vision for what he wanted to do in Newark alongside just having Audible there. And one element of that was he wanted to have a venture capital firm on the ground participating in the New York area venture scene and participating in the overall US venture capital world.
And I worked with him and a number of other backers. And then Dan Borok, my fellow founding managing partner launched Newark Venture Partners back then in those early days with a lot of help from Don and with the backing of Audible and through them, Amazon, Dun and Bradstreet, TD Bank, RWJ Barnabas, number of corporations and institutions that had presence there and wanted to both see that grow and thought that they, as organizations, could also benefit by being closer to venture capital, that they would be in a better position in their own enterprise by knowing what's going on in the world of innovation.
In addition to companies, there's a number of high net worth individuals and owners that are also LPs of ours, notably the owners of the Devils and the 76ers or a group of private equity guys from both Apollo and Blackstone who have been very active. In addition to having their money and their attention. We've also been able to, and it's a key part of what we do, leverage the connections that they have. So if we have a company that one of their companies or one of their people could provide some perspective on, they're openly involved in that and we've been able to use that perspective to make better investments and then have our investments make better connections within those organizations.
Alan Wink: So you've certainly come a long way in eight years and congratulations. But give us the elevator pitch on Newark Venture Partners, concentrating on fund size, investment focus, check size, and what was 2023 like for you guys in terms of investment activity and exit activity?
Tom Wisniewski: Yeah. So first to background. Well first of all we like to think of ourselves as a startup. We're investing out of our fund two. So maybe in startup lingo that makes us a late seed stage, maybe early Series A stage fund. Our first fund was 44 million, our second fund was about 90 million. We, as a firm, focus on B2B software, so we don't do consumer, we don't do hardware, other kinds of tech. It's software that businesses use to interact with other businesses for the most part. Within that we're thematic. We like to look at deeply a few different areas, do the research, spend the time in devote a good portion of our intellectual capacity to learning them and deciding we think there's opportunity there. And then we feel like that brings us to the conversations with founders very well-prepared to be able to add value from the beginning to have a point of view before we even start.
So we're thematic in that regard, those themes. Some health tech, FinTech, the industrial world, supply chain and such, or a few that we've mined over the years. We look to invest one to three million at the seed stage. We like to lead and co-lead. We like to try and get to a 10% stake and then hang onto it for a period of time. We're active before we look to invest and willing to know founders ahead of their need to raise money during the fundraising process. We like to be value added and feel like our founders should be getting something out of it regardless of what happens. And then afterward, our goal is to be involved. We often take board seats or board observer seats, but more importantly, want to stay actively adding value to the company and helping them along.
Alan Wink: Tom, as a leading accounting firm, an advisory firm in the tech space, we are introduced to founders all the time. We represent a lot of pre-seed, seed stage series AV companies. I went on your website and I noticed that you guys say we back bold founders building the next generation of enterprise software. What are the characteristics of a bold founder and how does NVP help these companies to build scale and eventually exit their businesses?
Well, there's a couple ways to answer that question. First of all, that's a website. So it's full of website lingo like everybody's is. But what I would say is that when you're putting something like that together and trying to be thoughtful, you search for words that to try to try and capture what the essence of what you're going for and that somehow we'll distinguish things. We want founders that exhibit a number of different qualities that we think are going to make them successful and great partners of ours.
One, given we're focused on B2B, they need to have domain knowledge of the industry that they're working within, that they're trying to change, that they may be trying to disrupt. So if you're doing something in logistics, you should come from there or part of your team should come from there. And we'd like to see our founders not be solo in multiple but all possible. But regardless, we need that sort of deep founder experience judgment in the industry.
In addition, we'd like to see someone as a part of the team that's been in a startup before, been a part of at least the growth stage company before, so understands the pace at which things need to evolve in order to be successful in the industry that may know something about how to raise money, the more the better, but certainly those two elements of the deep industry knowledge and the experience, kind of in the world of high growth venture backed companies.
And then rounding that out, we need to have technology skill in-house. And the idea and the area they're going after, and this may speak more to the bold part of it, is something where they're attacking a large difficult problem and have a solution that's not just an incremental solution to that, a little bit better, but something bold, something well differentiated within that, that we think has potential to grow into a large company.
Alan Wink: Very interesting. So let's spend a little time talking about the current state of the venture capital market. I think it goes without saying that 2023, or really the last 18 months, have been really a challenging time for both investors like yourselves as well as founders looking to raise capital. Last year about 171 billion of venture capital dollars were invested, well below the 242 million invested the year before and well below the 350 billion invested in 2021. The pre-seed and seed stages only saw 15 billion invested versus 24 billion invested the prior year. What's going on in the VC space? Are we at a tipping point and why the slowdown?
Tom Wisniewski: Yeah. I think anyone who's involved in the industry that's going to come as no surprise. We had a bubble where valuations had increased dramatically and huge amounts of capital were pouring in and those numbers you quoted as high points were historically super high points. So part of me, when I hear those stats and talk about that, my reaction is sort of, hallelujah, let's bring the industry back down to an area where it's sort of less irrational. That's a tough transition if you're someone who's in it. But I think overall, a good thing or an inevitable thing when you have these bubbles that in valuation and an excitement that burst up. So I would say 2023 continued to be a year of readjustment out of that, where those levels were decreasing. Still historically, that number you've got there is still a pretty high number and if you look at what dry powder on the sidelines that can go into deals, still at historical highs or near them. So there's still a lot of health in there relative to that.
What you definitely saw and you saw trickle down, and this is not just last year, but you're right, the '18, '21. As things broke apart and blew up at the highest end of the market, IPOs that went out and then are now trading at 10% of where they went out, companies that got valuations done and the billions of dollars during the heyday of 2021 now needing to raise money and being nowhere near that creates this disconnect and pulls money back from the sidelines to the sidelines. And that uncertainty there trickles down. You also saw, I'm as an early stage investor looking for later stage investors to finance my companies and they're holding off. That's going to trickle down into the market. The other thing we saw is that during the heyday, the larger firms had begun to be active in the early stages.
So there was money being thrown at companies in the seed stage by companies that weren't really familiar with that, really hadn't historically done a lot of that, that had helped knock up valuations quite a bit. It had also just put capital on the sidelines and names and firms on the sidelines that were just no longer there. So in that kind of an environment, as a company going through, if you needed to raise, it becomes a much more challenging environment. There are fewer firms out there jumping at things. There are valuation expectations have diminished dramatically. Depending on situation, if you're a firm that did a round that was at the valuation, that's that objectively someone would say is out of bounds now is twice what it was, you were faced with a decision about trying to make the money you had last so that your progress and your company could catch up with your valuation or by taking a flat round or a down round in order to continue on.
And I think the good founders saw that coming, felt it when it arrived and just you deal with it because putting your head into the ground and hoping that the high valuation, good old days, are going to return quickly is not a winning strategy. So what we have seen is a lot of, for good companies, flat rounds. If it was a valuation on the upper end of the market, often haircuts on those going down, which is I think healthy because it's getting back to the norms. And yes, it's difficult to raise money, but you also see that there's a flight to quality, good deals get done. Good companies, however you want to define that, those are perceived get done and your job, as a founder, is not to solve the macroeconomic problems of the industry and what's going on. Your role, your job as a founder is to get financed. You'll need to solve those problems. You need to solve yours to make your company appear as attractive as it possibly can, run a good fundraising process, and succeed in getting to the next round.
Alan Wink: So Tom, if we have a crystal ball in front of us, optimistic or pessimistic, about 2024? Glass half full or half empty,
Tom Wisniewski: It's a crazy year. I think the election is probably the easiest thing to point to say. There's just so much uncertainty and even though I think in the venture world we're pretty insulated from that, especially seed stage, and I'm so far away from the stock market that things there don't even have all that much. But I think no one can escape the level of just uncertainty given the political matchup we're kind of barreling toward. So I don't think there's any way it can possibly be anything other than a bit of both. I think that, put that aside, I think there's other signs that say that as well, and that is that I think valuations have reset a lot. I would say the deals that were getting done toward the end of last year and now are dramatically different. So I think it's very healthy. As a new investor into companies, I enjoyed that-
Alan Wink: When you say they reset, are we talking 10 to 15% valuation declines or more?
Tom Wisniewski: Oh no, in half. Things where someone would've come out of YC and said, I'm a seed stage company and I am going to raise at 32 with very little traction or 50 because I have some traction, are now down in the teens. So dramatically less now. There's always the exception to the rule. You got to take AI out of that and say that's its own bubble that's going on. That's another piece of the good news, maybe, or upward pressure or has been in the market, all the things going on in AI.
But generally speaking, no a reset. And that's taken a while. That's taken a while to kind of trickle down through things and you see that both in seed extensions happening a lot. So company may not be ready for its Series A yet, but it's doing well enough to continue to raise some money often at a flat or modest bump from the prior valuation. If that valuation was totally out of market when it happened, that may be a down round, but the idea is that company's continuing and growing and the past is the past for prior rounds. Surviving and growing is the goal.
Alan Wink: I've worked with many, many founders over the years and I think two of the biggest misconceptions that founders have are, number one, how much capital do they need to raise? And number two, why does the investor on the other side of the table say no more times than yes. So, for companies in the pre-seed and seed stage, how much money should they be raising? How would you like to see the capital deployed? How long should that capital last? And finally, what do they have to give up for that money?
Tom Wisniewski: So you're going to probably have to remind me, those were a lot of questions there to stay on track. What I would say is that my first answer to that and if I'm on stage, people are asking about how much capital should you raise? Should you raise capital or not now? My answer is honestly no. Don't raise capital. Do everything you can not to raise capital and continue to execute if you can because the longer you can do that, the more you can achieve. The more traction points you can achieve before you go out, the easier it's going to be.
So if you have a choice and you can bootstrap a while longer, that is going to be more than likely the right decision to make almost all the time. And particularly now, don't raise. Go get traction. Go make yourself more attractive. Whatever you can do today with whatever traction you have today, if you have two months more of it, you're going to look better. It's going to be easier to raise, higher valuation. Those things are going to work.
So I think that as a backdrop to this is accurate, but to answer your question more directly, I think amounts. Naming an amount out of the air is a sort of theoretical exercise. I think the right way to do is what could I raise today that would have a material difference on my trajectory over the next 18 months? So 18 to 24 months hasn't changed. I think maybe this pushing maybe to be at the higher end of that 24, 2 years months. So amount of money that would get me that long. And that would have a material impact on where I'm going, what I could do with that as opposed to outside of it. If you want to get into actual numbers, what I would say is that you probably used to see that "seed rounds" were a million, a million and a half, maybe two, that kind of grew up to three and then to five.
And then you saw and with that the valuations because of the desire not to get too diluted. What we've seen is that's come back down. We've seen founders saying things like, look, I can get by with a million and a half in my pre-seed, that's fine and I want to get back to work. What's behind their calculation I think is an honest assessment of the market probably too about what's going on in there, but a sense that I can put smaller amount of capital work, probably a shorter period of time, get stuff done, and then go back out to market perhaps even in a different environment. So maybe a million to 2 million kind of pre-seed, although certainly less than a million precedes happen all the time. For a seed round, three million, that seems to be like a number that's coming up a lot. And that lends itself to a valuation in the kind of low double digits, teens at least-
Alan Wink: Tell me-
Tom Wisniewski: Seriously, beyond that. Different world.
Alan Wink: Let me ask the last part of that question. And we all know that equity is the most expensive form of capital there is. If the company, the pre-seed and seed stage company, needs to go out and raise money, how much equity should they expect to give up when they're talking to a group like NVP? At the seed stage.
Tom Wisniewski: There's good rules of thumb to have in mind, and I think that's probably the reason why you're asking that. I would say it's 20, 25%. Could be as high as 30, but in that range is what a founder should expect to have happen. That said, it's a market process. People offer you money, they set valuations, you have the ability to take that money or not, or to keep shopping around. The market will clear that amount that you give away or what your equity costs you is set by supply and demand. So it's nice to have an expectation for it, but it'll be met with the reality of what's actually available there.
But something in that range I think is perfectly fine. And if it's a little less, hey, that's great, too. But there are downsides to raising at higher valuations maybe where you get less dilution, but that sets you up for a much higher benchmark that you need to hit down the road. But at the end I would say those are the kind of numbers and it's really about what's going to happen when you get out there and start getting interest from investors.
Alan Wink: I understand what you're saying because I think a lot of people raised money in 2019, 2020 at crazy valuations and they're up jumping up and down and they got these high valuations and now you get to 2022, 2023, and now '24, they have to raise more capital. They didn't accomplish what they thought they'd accomplish with the prior rounds and now all of a sudden they're subject to a down round and you're seeing a lot more down rounds now.
Tom Wisniewski: Certainly are, and a lot of flat rounds. If the company's doing well, maybe they don't deserve completely flat, but they'll get one because there's a certain support for good companies out there. But yeah, absolutely. And look, at the end of the day, it's disappointing, but there's nothing wrong. Surviving and moving on and building a company is what matters.
If this company succeeds and it had a down round in the middle of '23 or '24, but went on to become a huge success, do you think any of us are going to care? No, we're not. Because in the end it was successful. The founders stuck it out. If anything, we would look back at that founder in the book that they, he, or she writes and say, yeah, they persevered. They found a way. They didn't get too caught up in, oh, woe is me, the world's falling apart. They got it done. So I think that that's the right perspective to have. Got to get it done. Got to keep my company alive, want to keep growing, want to keep succeeding. If money is available but not at that rate, then let's do the best we can to move.
Alan Wink: So we're talking about survival and probably the outcome of surviving is an exit for your business. I think one of the biggest problems that all VCs faced last year was the issue of exits. There just were none. There were 66 billion of exits last year compared to 800 billion in 2021. As an early stage investor how do you look at the exit market and-
Tom Wisniewski: Well, first of all, I'm going to reject that comparison because you're comparing it back to those inflated years. So that 800 million is 800 million of IPOs that are now worth 10% of that.
Alan Wink: That's true. So true.
Tom Wisniewski: It was true. That did happen. And the volume of exit was there. And that was... Yes, but the reality of almost no exit. I am in a mode right now where I'm just not expecting any. I've reset expectations to, it's going to be the exception to the rule if anything exits at this point. It's a matter of trying to grow. Improve your company, move forward and situationally if something comes up, either you're forced to sell or you are in a situation where you have a partner or something and an opportunity presents itself. But other than that, I'm just not assuming there will be any. And I think that that largely has reflected the reality of the last year. There have been very, very few. That said, I think that during these times when there isn't a lot going on in M and A, it does pay for founders to be thinking about how they position themselves well for that.
How do I grow my company in such a way? How do I develop relationships in such a way that will make me more attractive to a potential buyer when things do turn a little better, when the economy for this sort of thing does turn around? So we have made an effort of having conversations with all of the portfolio companies, bringing in an investment banker even before there's any decision to do anything, just so people can get into that mindset about what's important and what helped companies like me, from the founder succeed in an M and A process. And what should I be thinking about now in the next two years if I want to be part of a successful sale two years from now or whatever it might be. And there's things you can do to align yourself, to think about your partnerships that you're having in such a way that maybe they will... They could lead to that partner buying you out or you just becoming attractive to a host of partners.
Alan Wink: So with this challenging market and the exit activity slowing down tremendously, are you advising your portfolio companies to conserve cash? Let the cash runway extend itself several more months?
Tom Wisniewski: Look, absolutely. You run out of cash, you die. Or your potential paths dry up completely. So you have to. Now, what does that mean? It means that, all right, depending upon where you are with your benchmarks and where you think you may need to be and where you're getting advised by maybe outside investors and your existing ones, where are you're going to need to be in order to raise your next round? You got to be thinking about getting there. So it's about making progress, most of all, continuing to get market fit and generate sales and traction and those benchmarks that are going to be allowed you do there. But yeah, you got to figure out a way to do that and give yourself sufficient runway. So a lot of what that has meant over the last two years has been being careful with cash, raising extension rounds because that's what's been possible, and making sure that you don't get caught in a position where you're short on cash, but haven't hit the benchmarks.
That said, the opposite is also true. You cannot cut your way to getting financed. There's no way to start cutting things back and flat line your growth to survive and have the outcome on the other end be investors who are going to be excited to invest in you. That just doesn't happen. So it has to be a balance because at the end of the day, unless you're growing, unless you're making progress and growing and growing fast, you're just not that interesting. So founders are faced with that trade off there, which is, yeah, I got to conserve cash because I want to own my destiny as much as I can, but at the same time, I've got to create growth. I've got to create advancement and milestones. Those things or all bets are off, at least as it relates to venture backing.
The other thing we have to always keep in mind is venture people is there are wonderful companies out there that don't fit the venture model, don't necessarily grow at those crazy rates that we need to see in order to balance the risk and reward that we've got. So the exit may be that this is a company that doesn't die, but maybe becomes a growth company but not a venture-backable one. There are other outcomes to fall into there. But if you're going to stay on the venture path, the only way to do it is by finding a way to grow.
Alan Wink: While we're talking about exits, we briefly discussed the issue of IPOs. That market has sort of fallen off a cliff and I think a lot of the frothiness of the tech ecosystem correlates to the IPO market. And I recently read there's about 700 unicorn valued companies that are still private today that received a billion dollar plus valuation their last funding round, and maybe they won't get that type of valuation in the public markets, but there's got to be a big backlog of companies waiting to go public.
Tom Wisniewski: I was thinking about this why question of why... Why has the IPO market been depressed? It opened up for a while and then it's kind of back to where it was, if anything. And if you looked at those companies and you put aside for a moment the hype, those unicorn companies, we'll just define those as companies that are doing really well and have grown a lot and people are excited about. There are a huge percentage of them that if you looked at their fundamentals, their growth, the aggregate size that they're at, they would fit into a window of a company that could be IPO, that could be on the IPO market. That's not the problem. Now, yeah, there's regulation. There may be reasons, there are hassles about maybe why they may want, let's put that aside too. I don't think that's constraining them. The problem is that they've stayed private for long enough that the valuation that their private market is giving them is a mismatch.
It's just not something that's going to get supported by the public markets in this environment. So either this company needs to grow to the point where it can justify that valuation and then when they go public, it feels like they're getting full value for what the private markets gave them, or it's got to be reset. So there's not a problem with the company. A lot of those companies are good, they're big, they're making money, they have hundreds of thousands, hundreds of billions of dollars in revenue. But valuation is a mismatch. And it's interesting because that's not a business problem. That's an expectations problem that's in there. And that's kind of constrained, which is sort of a shame. It's sort of the upshot of companies having stayed private as long as they have. Shields them of a bunch of things is a growth path that can make a lot of sense. But at the same time, it's allowed for this disconnect to creep in between expectations in the public markets and the private. And that's really the barrier.
Alan Wink: It's funny because last year people thought the IPO market was going to turn itself around earlier in the year, there were a couple of large IPOs, but even those companies that were much further advanced, they were seeing 20 to 30% revenue growth. They were cashflow positive, and even those type of companies were getting valuations in the public markets way below what the last private round was. It's kind of interesting.
Tom Wisniewski: Yeah. And if you look at those, and it's always disappointment because look, I'm on the private market side. I want to see those valuations get supported so that a company when it goes public and creates liquidity, provides a return for all the early stage investors and the rest, that's great. But it's a market. It's supply and demand. If the market's telling you that they're not going to value it any more than 10 times revenues, which is still a shitload of money, then that's how much you're worth. And it may still make sense to do that. There will be winners and losers, later stage investors will not do as well and maybe be underwater and lose money, but that still may be the right thing for that company to do to get out there.
One, it creates liquidity for the existing investor base. Hopefully, it also positions the company for continued growth, given the access they have to the public markets for continuing to raise company. But I think at the end of the day, there's always some sentiment in the market that's going to beat up on something or heighten something up. But in the end, my sense is the disconnect is just in valuation multiples. There are companies out there that I think could be... That they're big and could be public. It's just what would the valuation be and whose investors would that satisfy?
Alan Wink: So Tom, I always promise myself I try to end these discussions on a high note and I think any discussion of-
Tom Wisniewski: Do you do that by your voice?
Alan Wink: See, I got you singing, but there you go. I think the one bright spot has been AI or machine learning. I think about 20% of the VC deals last year were AI related. Where do you see AI opportunities in your space and how much of a game changer do you think AI is going to be in the future?
Tom Wisniewski: All right. So I'm sorry. First thing I'm going to do is on your parade and say, I think AI, the reality of it is it is super hype cycle. And we're going to talk about AI and AI moving into 2024. I think on the Gartner scale, we have reached peak hype, at least in this iteration of it. We're going to hit it again. So my feeling is definitely like crazy amounts, valuations and all this money going into things. So I look at that as a little nutty. I don't think a regular seed investor, someone who's not investing seed stage at a billion, right? It's another world and to me that's cool things, great tech, but a distortion, and I see that kind of coming down. So to me, yeah, excitement, but I think it's heading into a downturn and as part of this hype cycle and as an investor, you try and stay away from hype cycles because they can get you in trouble.
Full stop. I'm incredibly excited about the potential for AI as a technology, as a driver of great ventures. It's a tool. It's like saying cloud computing before that was a big thing, or SaaS before it was a big thing. So I happen to believe it is a technology and all those things that has incredible staying power and will be driving all sorts of big companies and great outcomes and cool things. For me, it's in the application layer. So I'm going to stay out of the infrastructure, the LLMs and whatever replaces them. The tools, the tools underneath that that help that. Maybe make it better. Challenging the application layer, there's a tremendous amount of great stuff going on there and I think that's a trend that will do many ups and downs with AI, but I think there will be... It'll define the next 10 years.
Alan Wink: Tom, I think we're out of time. I just want to thank you so much for spending some time with us today. Your comments were awesome and I look forward to talking again. I'll hand it back to Astrid.
Transcribed by Rev.com
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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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