I wrote a short article for Antler Insights, the early-stage venture firm that I joined in July.
You can see the post on Antler’s blog “Insights” here, and copied below.
Will 2023 be the best vintage of the coming decade?
Kevin Brennan, Antler—November 2022
2022 has been a year of dramatic and unprecedented scenes. Now that we are half-way through Q4 and the outlook is still unsettled, will the tension and drama continue, or will the array of challenges start easing? Signs are not looking good. The timing and duration of a well-forecast recession are still difficult to call, we are in a historic IPO drought, an ugly war of attrition wages on in Ukraine, and regular natural resources calamities and unsettled social structures are seemingly “normal” for the foreseeable future.
Looking at the technology sector—so central to the venture capital landscape—the last year has brought the steepest and widest drawdown for a generation. And the long period of low cost of capital supporting fast-paced growth in revenues seems consigned to history, leaving most investors uncertain of how economies will respond to an interest rate trajectory not seen since the 1980s.
In venture capital specifically, as at end of Q3 2022, activity measured by exits is down against the historic levels achieved in 2021 and Q1 2022 but still well above historical averages.[1] At the same time there has been a uniquely positive aspect of 2022 for the venture industry with US and global “dry powder”—funds available to be invested—standing at a record $572 billion[2] globally and $290 billion in the US.[3] Today, VC funds are very well stocked to make rounds of new investments at much healthier valuations compared to one year ago. However, the dramatic valuation gains of the last five years mean established venture investors are typically overexposed within portfolios (“the denominator effect”), pausing on new allocations. At the same time, new institutional venture investors are appearing, especially in family offices, foundations, and endowments (along with their outsourced CIOs), all assessing how to build venture exposure for decades to come.
Amidst all the uncertainty, the world in 2022 is shaped more than ever before by the “certainty of innovation,” as Antler President Ed Knight wrote earlier this summer in Venture Capital Journal.[4] The breadth and global nature of new innovations in early adoption mean the technology sector should quickly find itself back in the driver’s seat as business and capital market cycles turn.
So with these simultaneous realities—the current downturn and unstoppable innovation—continuing at pace, what can we observe from history when assessing how to position in venture capital for the rest of 2022 and into 2023?
Might 2023 be the best vintage for the coming decade?
What we can learn from history—innovation and company formation
It’s almost over-written that recessionary times bring out the best in exceptional entrepreneurs and young companies. Like an ice bath to a strong athlete, the shock from rapid change in the environment is healthily uncomfortable to those who can cope, forcing rapid adaptability and resilience while narrowing operating focus and creativity.
The strongest companies are quicker and more adaptive to cost efficiency needs, customer acquisition gets cheaper, and the hiring landscape gets easier to compete in. (Competitor layoffs and reduced stock option values in bigger corporations mean the opportunity cost of quitting to join a startup you’ve had your eye on for some time is lower.) In addition, the most talented entrepreneurs and companies enjoy competing to secure new capital rounds in an environment where investors get much more selective.
When researching this article, I was reminded there are secular aspects to bear in mind, over and above the capital market cycle. Accel founder Arthur Patterson, whose lifetime of venture experience spans multiple market cycles, shared with me the observation that the supply of innovative new companies is the real determinant of overall longer-term returns, created primarily by technological innovation but with social behavior trends also a factor in enabling new company supply. These secular factors in the formation of new companies are independent of VCs or IPOs. Consider how 2008 was not only a nadir in the business cycle but also a pivotal year in the development of mobile (iPhone 2 released ex-US and with 3G) and cloud computing technologies (DropBox first software release, 2008, with iPhone app 2009). Facebook and Twitter would not have gone viral in the same way in the early 2000s on desktop web browsers as they did on smartphones from 2008-10.
Psychological factors play an important role in private capital markets, just as they do in public markets, through the interplay of sentiment and execution. In roaring times, Arthur commented, “optimism about the timing of new VC projects ‘pulls forward’ in time the execution (new company), while in depressed environments higher levels of caution cause delays in entrepreneurs or VCs starting new companies to capitalize on the same new opportunities. Also, in a depressed environment, you have far fewer companies starting to chase the same market opportunity—a potential big plus in returns.” From a similar angle, innovation economist Steve Klepper observed, as cited in a Morgan Stanley paper this summer,[5] that compression years within an innovation cycle valuably narrow the experimental options of abundant years into what is most appropriate for the tighter environment.
I looked even deeper into the history of cycles, revisiting some old reading on the work of renowned economic historian Carlota Perez, who specializes in the shape of technology cycles going back to the 1770s. Perez brings optimism to the nature of this current downturn, having forecasted this slowdown some years ago as a critical turning point mid-way within the fifth industrial revolution of IT and telecoms technologies.
Optimistically, Perez foresaw today’s “turning point” as a necessary precursor to a more sustainable golden age that will be “led by production and the improved shaping of markets in a positive sum game for business and society.”[6]
What we can learn from (recent) history—VC fund performance
In September Morgan Creek released an insightful analysis on venture fund performance across the last cycle. Looking back to the Global Financial Crisis slowdown of 2008-10, Morgan Creek reported superior returns in the vintages emerging from recession across nearly all major performance metrics. 2010 is the standout vintage, where a GP in the top 5% would have generated over 12x net TVPI. The best performances are in those years closer to the downturn when looking at total value to paid-in (TVPI) and distributed value to paid-in (DVPI) multiples.
Even more interesting, within the universe of venture fund performance assessed, Morgan Creek’s work observes early-stage funds significantly outperforming later-stage and multi-stage managers in the years 2010, 2011, and 2012, with pooled net IRRs of 32.3%, 23.6%, and 19.4% for those respective vintages.[7]
Source: Morgan Creek “History, Brain Development, and a Quality Reputation: Early-Stage Venture Capital Performance When Emerging from an Economic Downturn” (September 2022). Morgan Creek note: “there were no funds that met Cambridge Associates’ late-stage criteria in 2009. For graphical purposes, we averaged the late-stage venture pooled net IRR in 2008 and 2010 and used that as a representative statistic for 2009. Further, the data labels within are used to depict the net pooled IRR returns of early-stage venture funds only.
Data-science driven VC investor Equiam looks back further in its analysis, in an excellent article on venture capital historical performance during skittish markets, “The Case For US Venture Capital Outperformance.” Equiam identify venture capital “golden periods” across recent history, where top-quartile VC outperformance—with TVPIs exceeding 4.0—typically strikes three-to-four years after a certain threshold of yield curve inversion, per 1993, 2004, 2010, and our current trajectory as we approach the end of 2022.
Source: John Zic, Schachi Shah, Equiam, in TechCrunch, “The Case for US Venture Capital Outperformance” (September 2022).
Digging into underlying company valuation data, 8VC recently summarized their findings[8] on underlying company valuations during the same period. The analysis notes that in 2009-2011 the down rounds and flat rounds (i.e., lower-than-expected valuations, signaling investors finding deals at the right price) outperformed the up rounds (investors accepting higher valuations in strong demand for the round), while the opposite was true in all other years, all of which were bull years.
Antler internal research in response to prospective investors’ questions shows that the closer companies have been to a potential exit (i.e., later-stage companies), the closer their correlation to public market valuations and so the greater the valuation inflation during the strong markets of 2021. Moving backward through funding rounds, the valuations at which companies raise become increasingly uncorrelated to public markets. We observed this within AngelList Real-Time Startup Valuation Data Indices[9] that showed how private markets also adjust, with less impact on earlier-stage companies. This is somewhat intuitive given that early rounds are a negotiation between founders and investors over dilution, with no underlying financial fundamentals to value the company on, making them cheap relative to the potential outcome. With the $520 billion of dry powder globally, venture capital investors are funding companies earlier to secure future optionality, providing significant stability to early-stage valuations.
Lastly, it’s important to mention Cambridge Associates’ 2019 research that explores the performance of new and emerging managers against more established funds. The conclusion: new and developing fund managers consistently ranked as some of the best performers across the last cycle (data set spanning 2004-2016).
Source: Cambridge Associates, LLC Private Investments Database, “Venture Capital Positively Disrupts Intergenerational Investing” (January 2020). Cambridge Associates notes: Pooled total value to paid-in capital (TVPI) multiple is net of fees, expenses, and carried interest. Fund order is determined as funds raised under the same strategy and does not include friends and family funds. New fund is defined as the first or second fund, developing fund is the third or fourth fund, and established fund is the fifth fund and beyond. Vintage years formed since 2016 are too young to have produced meaningful returns. Vintage years with less than 40 funds in the sample have fewer than 10 funds in the first quartile; in 2009, the first six funds are top-quartile, the last four funds are second-quartile.
How is Antler positioned in this time of uncertainty and innovation?
Almost three years ago, I first met Antler founder and CEO Magnus Grimeland, a meeting that led me to excitedly join the firm in July. Magnus spoke about how the venture industry was rapidly changing. I remember his comments on how traditional ecosystems were often ignoring the rapid globalization of innovation and local capital market development in new parts of the world. He also talked about the opportunity Antler saw to build venture capital ecosystems in whole new geographies, with new talent sources and untapped networks.
Sebastian Mallaby, the leading international finance and economics author, sets out how he sees the future of venture similarly in Power Law: Venture Capital and The Making Of The New Future.[10] The forthcoming differentiation in venture will emerge from new regions globally,[11] founded on specialist sector networks that accelerate getting things done, and on the replication of proven business models into new global markets (“the X of Y” playbook, as it is called). At Antler, we also believe that data science and statistical analysis capabilities—as well as the embedding of environmental, social, and governance factors into company values and operating systems for long-term value creation and resilience—are critical to building the defining companies of tomorrow.
Antler’s business model is built on our conviction that within these new venture ecosystems, great companies come from finding and backing the very best people and teams, and being their best possible partner from day zero. As Tyler Norwood said in a podcast focused on how Antler programs are positioned to drive new companies to success, “Either VC dollars stay but there are not enough great businesses. Or can we catch up the number of great teams, and so massively drive innovation in a sustainable way.”[12]
Payment systems are an example of these rapid regional developments, emerging as a comparative advantage in the initiatives of founders from the Netherlands (Onramper, for example), and Antler’s climate tech and sustain tech business are emerging from our Nordic locations in particular (while appearing globally) with companies such as Glint Solar and Ocean Oasis. Antler founders in India have particular interest and expertise in Web3 innovations (Juno and Flint, for example) and we see strong continued growth in expertise in consumer tech coming out of the Southeast Asia region, with investments in Reebelo and Airalo.
So, with the three years of “overhang” in capital committed to the sector, Antler believes we have a huge opportunity in the coming year to contribute to growing the supply of the world’s most exceptional founders. And to enable our investors to back these driven, talented, and resilient people who are building companies that shape our future by addressing the most pressing challenges of our time.
Through our Antler teams working with founders in 25 cities, we bring our investors unrivaled breadth of access and diversification: six continents’ worth of innovation exposure to companies being built by the most talented founders (with investment entry points at structurally low valuations given our earliest-stage participation). We believe Antler is uniquely well-positioned for how the next 10-20 years in venture capital will differ from the last 10-20 years.
To conclude, during this downturn we must remember that our role as venture investors—to back and to build the future—is even more important. This requires a long-term view that with time, and by finding and backing the most talented and innovative business builders globally, venture investment can build the defining technologies and companies of the future.
Together with our LPs, we will reap the rewards of the value these exceptional teams create for the world. The evidence is stacked in venture investors’ favor: the 12 months ahead are a critical period of opportunity to deploy to venture capital, and to be optimally positioned for the shifts and innovation ahead.
As Antler’s Ed Knight said in a podcast earlier this summer, in this era of innovation “the whole world is going to end up being invested in venture capital.”[13]
Kevin Brennan is an Associate Partner on Antler’s Global Capital team, based in San Francisco and working with Antler’s US and Canadian institutional investors.
[2] Ibid.
[3] Jon Sakoda, “Opening the Floodgates: The $290 Billion Venture Capital Reserve” (September 2022).
[4] Venture Capital Journal, “Investing in The Certainty of Innovation” (August 2022).
[5] Morgan Stanley and Counterpoint Capital, “New Business Boom and Bust” (June 2022).
[6] Carlotta Perez, The Fifth Industrial Revolution is Happening—Is it Time to Reshape Our Future? | Summit 2018.
[7] Morgan Creek, “History, Brain Development, and a Quality Reputation: Early-Stage Venture Capital Performance When Emerging from an Economic Downturn” (September 2022).
[8] 8VC, “The Once and Future King: VC as an Asset Class in 2022 and Beyond” (September 2022).
[9] AngelList Venture website.
[10] Sebastian Mallaby, The Power Law: Venture Capital And The Making Of The New Future (February 2022).
[11] Venture capital flows are now more than half ex-US, Economist, “Can Silicon Valley Still Dominate Global Innovation” (April 2022). The article cites Bengalaru, Singapore, and Sao Paolo as being “in earlier stages of hub-dom…re-drawing the map of global innovation…one that is more dispersed, diverse, and competitive.”
[12] The Puck: Venture Capital & Beyond (podcast), “Tyler Norwood of Antler” (August 2022).
[13] Ed Knight, Antler in ValueWalks’ ValueTalks (June 2022).
