It feels strange, what is happening with valuations.
Prices are high and volatile. Public equity PE ratios are among the highest in history. Startups are seeing unprecedented valuations, too. These trends tell a story about the economy — and about investor appetites.
The world is changing fast. Innovative products and services are scaling faster than ever, and value is being created faster and more efficiently than ever. Unicorns are now “decacorns”, and YC portfolio companies are worth half a trillion dollars in aggregate. Modern software tooling is great, costs are down, and markets are super dynamic. Adoption of online services is happening faster than I have ever seen — business adoption, especially.
The gold standard for ARR growth used to be 3x for a year and then 2x for two years. Now many companies grow much faster than that. Rising valuations in tech reflect the belief in the value of scalability in the digital economy driven by low marginal costs. Revenue growth can be historically fast, and investors want that upside.
Accelerated growth is only part of the story.
Endless stimulus has flooded the economy with capital seeking deployment at any price. The US Dollar monetary base has exploded since 2010, contributing to inflationary pressures that make it difficult to justify holding cash. The pressure to use and invest cash also drives more investment as cash is expected to lose purchasing power over time. Stimulus pours, like a flood, into every asset class and drives up valuations.
Stimulus and inflation expectations are also only part of the story.
Crypto and other currency options proliferate with a beautiful diversity of strengths and use cases, calling into question the continued dominance of the US dollar. Software is eating the world, and now this trend is disrupting global currency and financial services markets. If crypto and foreign currencies reduce the growth in demand for US dollars, this could contribute to inflation at the same time that it stimulates tech adoption.
All of these factors are driving both institutional and retail investors into riskier assets like venture capital, crypto, and stocks as they seek to outperform inflation and earn returns and yield on their capital.
The bond market is not immune. Bond investors have been lulled to sleep by global central banks and 40 years of falling rates. Yields have fallen and risk premiums have compressed. Bond investors, too, are seeking yield from riskier debts, and it is no longer safe that bond funds will outpace inflation. Negative real rates of expected return in the bond markets reflect high valuations and excess capital in this market, too.
At Broom Ventures, we looked at over 850 startups this year. We invested $5.17m in 14 companies. We have seen a dramatic increase in early-stage valuations, and the quality of startups and their growth rates seem stronger than usual. A proliferation of venture funds and a huge increase in fund sizes means that there are now more investors deploying more capital into this relatively small ecosystem. Founders of attractive startups have stronger negotiating positions than in the past, and are getting both higher valuations and more non-financial contributions from investors than I have ever seen.
Heading into 2022:
The ceiling on growth rates seems permanently lifted, suggesting increased and diverse exposure to tech and VC. The risk of rising inflation suggests reduced allocations to medium and long duration bonds. Inflation also suggests evaluating your stocks differently: are they companies with pricing power? If inflation comes, will they raise their prices or are they caught against tightening margins? Diversify: resilience is strength. I think it’s a good idea to learn about DeFi and to consider holding crypto, owning real estate and other real assets, and diversifying with global stocks.
Disclaimer: This is not investment advice.