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Neil Andrew

The Year of the Writedown: Coming Back Down to Earth for Private Equity and Venture Capital Valuations.

By Neil Andrew, CFA

If you own shares in private companies (or were thinking of investing in private equity or venture capital), many of this year’s headlines have likely tested your resolve. Three quick examples:

•    On July 11th, the Swedish fintech company Klarna said it raised $800 million in fresh funding at a $6.7 billion valuation — down sharply from $45.6 billion a year ago. Despite Klarna CEO Sebastian Siemiatkowski’s comment that the deal was a “testament to the strength of Klarna’s business,” the new raise represented an 85% decline in the company’s valuation.

•    During mid-October, Instacart announced in a company meeting that it was slashing its valuation to about $13 billion, down from the $39 billion it was valued at during a March 2021 funding round. The writedown to $13 billion marked the third time this year that Instacart lowered its valuation. 

•    And then there’s FTX. When the exchange collapsed, institutional investors wrote their (often substantial) stakes in the company down to zero or close to it. For example, on November 10th, Ontario Teachers Pension Plan announced that it had invested a total of $95 million in FTX. With the exchange’s collapse, that investment is now likely worthless. 

These are just three, albeit extreme, examples of falling private valuations. Other well-regarded companies like Bytedance (the company behind TikTok) and Stripe have also written down their valuations (at least internally) this year. Seeing these declines begs the question: is the party over for private equity and venture capital? Should investors just go back to the public markets? 

The short answer: not at all. Leaving aside, for the moment, valuations for these companies, the reality is that the world’s most exciting, fastest-growing companies are almost all private. If investors want to participate in the top new growth areas within artificial intelligence, machine learning, climate tech, digital payments, data security, blockchain, entertainment and social networking, etc., the only way to do it is through private investing. In other words, finding the Apples and Googles of tomorrow (both public), starts with finding the SpaceX’s and Stripe’s of today (both private).          

So, maybe the real take-away from the “year of the writedown” is not to avoid private companies, but instead to invest in them just as the leading institutional investors in the world do. Here are three lessons to keep in mind during this pullback.

Lesson One from leading institutions:  This is not a DIY business. You need to invest the same way institutions invest into the asset class – by investing in funds.

It’s important to understand that even large institutions, like pensions and endowments, rarely invest directly in private companies. Rather, they make capital commitments to funds managed by well-established PE and VC firms like Andreessen Horowitz, Blackstone, KKR and Sequoia. 

These managers have phenomenal access to companies and see tremendous deal flow as a result. They have deep investment expertise augmented by teams of operating partners and industry experts – all of which work together to help build and grow these companies. These managers also have considerable experience shepherding companies through various business cycles, including past downturns and periods of crisis. Ultimately, you want to invest with people who know how to weather the storm. In short, this is not an easy group to compete with when it comes to selecting the leading companies of tomorrow. And it should come as no surprise why institutions choose to invest through funds.         
Lesson Two from leading institutions: You can’t avoid the FTXs of the world, but you can diversify to mitigate their impact. 

Not putting all your eggs in one basket is a generally well accepted principle amongst most investors. Big institutions are no different – as they understand that not every private company will become a huge winner. So, when it comes time to build a diversified portfolio, their managers and in-house teams buy stakes in dozens, if not hundreds, of companies. This diversification ensures that if one investment is written down, or even written off, the impact is negligible and often offset by the strong performance from other names in the portfolio. Remember that writedown of FTX that OTPP took? Here’s their comment on its impact:
Teachers said the writedown will have only a “limited impact” because it’s less than 0.05 per cent of the $242.5 billion pension fund. “However, we are disappointed with the outcome of this investment, take all losses seriously and will use this experience to further strengthen our approach.” 
So, while $95M is large in absolute dollars, OTPP has the diversification to ensure that its long-term investment goals won’t be unduly harmed by the FTX failure. Other investors in private equity should take a similar approach when it comes to diversification. 

Lesson Three from leading institutions: Focus on the opportunities in this market NOT the valuations at the peak of the euphoria.

New funding rounds, alongside discretionary markdowns, are increasingly reflecting the latest views on current trading multiples. In other words, the new macro reality, alongside various sector and company-specific developments are at least beginning to be “priced in”.

However, it is important to note that the writedowns of the past year relate more to valuations than meaningful changes in the businesses themselves. Many technology companies, for example, are still growing rapidly despite a now slowing economy. However, in this period of rising interest rates and increased uncertainty, capital is simply more expensive. While this can present challenges for companies looking to raise money, and has implications for existing shareholders, this market is presenting tremendous opportunities for investors with capital to deploy.

For seasoned buyout and VC investors, with strong deal flow and the necessary expertise, they can choose to back the best companies on more favourable terms – creating a potential for outsized returns, alongside a degree of downside protection. 

Similarly, for secondary investors like Overbay, we can achieve a compelling risk-reward proposition by negotiating discounts on the fund portfolios that we purchase.  Discounts allow us to buy exposure to the world’s leading companies at attractive valuations – and builds in downside protection as well.  Given the need for liquidity in this market, secondary investors can simply buy such exposure at much lower valuations than available elsewhere. 

That is our focus at Overbay Capital – acquiring institutional-quality, diversified, global private equity at discounts. And by investing in institutional-quality funds, taking diversification seriously and using the secondary market to achieve even lower valuations, we believe that we can deliver a compelling risk-reward for our investors…even as private equity and venture capital valuations “come back down to earth.”


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