Technology companies fueled by venture capital and private equity money have to find a more conservative financial path to success, said three prominent tech investors at the Forbes Iconoclast Summit in New York on Thursday. That will require being much more mindful of cash flow, expense management, and financing availability.
While a widespread slowing of technology buying is not yet evident, higher interest rates and the fleeing of capital from the space are bruising once-pristine tech valuations.
“What we’re seeing is a classic correction,” said Anton Levy, chair of the global technology group at General Atlantic, an investor in Alibaba Group, Crowdstrike, Facebook, Uber, and other big names. “You had classic late-cycle behavior where a lot of people saw the outperformance in tech and a lot of new entrants [came in],” he said. ‘Now that’s starting to unwind.”
In the public markets, the Solactive FANG Innovation Index — which includes large-cap tech stocks like Meta, Apple, Intel, Nvidia, and Salesforce — was down more than 45% this year as of November 3.
The drop in tech valuations in the private markets is not as far along, said Levy. He expects the bottom won’t be seen for at least another 12 to 18 months.
A down macroeconomic cycle is new to some investors and founders in the tech space. “The venture world is starting to realize over the last six months how important that is — it’s a big shock to the system,” said Lydia Jett, a managing partner at Softbank Investment Advisors who has led investments in high-profile e-commerce and consumer internet companies.
To adapt, Softbank is “spending a ton of time” with its existing portfolio, “making sure that those businesses make the course corrections they need to be successful.” One of those course corrections is “descaling” businesses, said Jett.
“These companies need to simplify and get back to a different market positioning because they will have to enter a very different market from a financing standpoint,” Jett said.
Nearly all of Softbank’s portfolio companies have a year or more of financing runway, Jett said, but Softbank is asking founders to get to a level of business sustainability faster. At the same time, it doesn’t want founders and C-suites to abandon long-term growth plans. That’s a difficult combination, but necessary.
Businesses can’t just “myopically focus” on cash flow, Jett said. “Because there’s too big of a hurdle that we have to climb out of from a valuation standpoint.” Personally, Jett doesn’t think market multiples will return to anywhere near where they were. “And so if you believe that, clearly these businesses have to get much, much larger,” Jett said.
The portfolio companies of private equity firm TA Associates entered 2022 with some big growth plans and budgets, but now CFOs and CEOs have to change that mindset, said Ajit Nedungadi, CEO of TA Associates.
While TA’s companies — recent investments include Aptean, Hornetsecurity, and Technosylva — have yet to see weakness in business-to-business tech markets, executives “need to be much more focused on very tight management of expenses [and] zero-based budgeting [as a general theme] going into next year,” Nedungadi said. Portfolio businesses have to be thinking forward to a softer demand environment — “we don’t know what the demand economy is going to look like,” he said.
The other area TA Associates is spending time on is capital management.
“Especially for our younger folks, we really have to be focused on [the idea that] EBITDA does not equal cash flow,” said Nedungadi. “Cash flow is the only thing that matters as you enter an interest-rate environment where cost of credit has gone up by five hundred or six hundred basis points.”
General Atlantic is not trying to predict where the economy is going to be next year, but it is looking at recession cases, which now have a higher probability than two years ago, said Levy.
“When we make any new investment — we have done this for a while — we’re saying, ‘Look, here’s the recession case. And what are the [risk-adjusted] returns like in a recession case?’” Levy said.
TA Associates is “watching very carefully for every key performance indicator, whether it’s a bookings metric, whether it’s a [customer] retention metric, whether it’s the ability to increase prices,” Nedungadi said.
“There’s a lot of watching, observing, and trying to get data as quickly as possible to be able to respond and to ensure we’re prepared.”
Despite all the caution, venture capital and PE investors are still very optimistic about long-term trends in innovation and technology. While it’s not a good time to be exiting companies, equity investors with patient capital — a five- to seven-year time horizon — over the next couple of years will find it a good time to put money to work, said Levy.
Companies that had two to three years of cash flow are “suddenly going to have six to twelve months of cash flow mid-to-late next year, and they’re going to be thinking about raising money again,” said Levy. “Multiples will stay pretty depressed … but that’s an opportunity for new, patient capital.”
While the volatility of the markets is keeping Softbank from investing aggressively, the firm is still excited about what’s ahead for technology-driven innovation in many tech categories, said Jett.
“This is a moment of optimism for us,” she said. “Because we don’t have the advantage of being able to trade in and out on a quarterly basis, we’re making long-term bets based on really long-term thematics.”