Investments in tech start-ups in Canada are down 71% this year, compared to 2022. You sleuths that you are, you probably deduce that it is more difficult for start-ups to find work. money these days. Valuations have taken a beating, too, especially compared to 2021, a bygone era of queuing to convince the founder of the latest delivery app to accept a check with eight zeros.
But in an already complicated environment, could these companies still be grossly overvalued? Will tech start-ups follow the path bravely blazed by Florida residential real estate in 2008?
So thinks venture capitalist Nnamdi Iregbulem, who recently put forward a theory to this effect in a text titled The Shadow Price of Venture Capital.
In summary, he argues that if we follow historical trends, start-up valuations would still be significantly too high, given the dramatic drop in the amounts invested in the sector. Indeed, according to his analysis, each dollar of investment that disappears from one year to the next should lead to a decrease in the valuation of the companies financed by $0.66. However, declines have only been $0.40 per dollar lost since peaking at the end of 2021, meaning valuations could still fall substantially.
On the face of it, the reasoning makes sense: many companies have chosen to delay their fundraising rather than close on unfavorable terms.
That said, no matter how much you have the opinion of a financier with degrees from Yale and Stanford, you can never be certain of the latter’s real motives or the way in which the data was treated in his analysis. It is therefore a good idea to see if we perceive other signals.
A story of the employees is useful here since they are closer to the action than the financiers. To get their opinion, we considered doing a vox pop at a Mile End café on a Tuesday afternoon, but decided against it. Fortunately, in mid-June, Peter Walker, of the American company Carta, published a very enlightening report on trends in the world of stock options.
First, it should be remembered that start-ups often pay their employees in options, which give the possibility of buying shares of the employer at a fixed price for a given period. If the stock is worth $1 when hired and $10 when the option is exercised, the employee pays $1 and makes a profit of $9. Everything is fine, provided the company has gone public and you can sell your shares immediately. However, if the company remains private, we can certainly boast of making a gain on paper, but it is not always easy to convert this action into dollars afterwards. Therefore, it is a risk to buy it, even if you often benefit from a good price.
Carta tracked all options expiring in May 2023 to see if employees were exercising them. Counting only stocks that have gained in value (thereby excluding struggling companies), only 36.6% of employees have exercised their options compared to 56.4% who did so at the end of 2021. So that’s only one in three employees who choose to invest in their business, even getting a discount.
What’s more, this percentage has fallen almost every month since November 2021. Is it because employees expect stocks to fall in value, want to keep their funds liquid in an inflationary world, or do they prefer invest elsewhere during low tide? Maybe a bit of all three.
Glass-half-full followers will argue that despite the 71% drop in investment volume, there’s still huge excitement over any company selling a variation of the letters “AI” or “GPT”, in reference to the artificial intelligence. The latter continue to accumulate capital, unlike many of their counterparts.
There also seems to be the same fervor on the public markets side, where the companies that benefit the most from artificial intelligence (AI) have been performing quite well so far this year. In fact, if a stock chart in 2023 looks like an upward ladder or the trajectory of a rocket, you can bet an old $2 that artificial intelligence had something to do with it. We are thus quietly shifting into a world where there are two types of societies: those powered by artificial intelligence… and the others. We can then think that this bodes well in the long term for start-ups in the sector.
In other words, despite the drop in volume and doomsday predictions, some will still hit home runs this year. It is therefore necessary to avoid lingering too long in the headwinds. You still have to see the tides coming to navigate well in this rough sea…