December 2, 2023

we are very It’s been fun today. Rarely have we seen so many structural changes happening in real time: high interest rates, falling stock values, SVB and other banks failing due to ongoing contagion risks and a looming recession.

Hypothetical equity returns change dramatically compared to fixed income returns. The data tell a clear and extreme story.

In short, the equity risk premium (ERP) is well below the range established since 2008. ERP calculates the expected return on the S&P versus the return on the 10-year Treasury note (data from Morgan Stanley).

The chart below is important to the startup audience because it illustrates why fundraising is now extremely challenging, and why valuations are falling so fast. The opportunity cost is indeed powerful.

For the venture capital space in particular, this dynamic has been exacerbated by the cooling of the venture debt market, which in turn has made equity the most viable option for most.

Image credits: irving investor

contributing factors

It turns out that waiting for public market multiples to rebound to maintain previous valuations is not a good strategy.

Venture capital activity has declined

VC capital layout continues to slow down. SVB measures inflows and outflows of deposits through a metric called total customer funds (TCF), which has been negative since the first quarter of 2022 (for five consecutive quarters now).

This trend continues in 2023: VC capital deployments are down another 60%, and the number of deals is down about 25% from a year earlier.

The decline in VC activity combined with the decline in ERP is a clear signal that a major correction is needed in the valuations of private tech companies. Interestingly, however, we have seen that valuation expectations for private companies remain high relative to clearly public comparable companies.