As Markets Gyrate, Startup Investors Search for Success Where ‘VC Meets D.C.’

Get ready for a seismic shift in the venture capital (VC) industry.

Amid the downturn in the public markets, the swoons in the Nasdaq (down more than 20% YTD), the PYMNTS FinTech IPO Index is down even more, off a staggering 35% YTD through last year.

Read also: Amid Thursday’s Tech Bloodbath, FinTechIPO Names Hit Harder Than the Market

That index could be used as a proxy for the new and emerging technologies tied to the great digital shift and the early-stage capital committed for companies that ultimately went public (which is a typical VC exit strategy). Call it the great fizzling.

“VCs were getting greedy,” SineWave Ventures Founder/Managing Partner Yanev Suissa told Karen Webster, and backing funds worth billions of dollars that presupposes that there would be 300 great companies to invest in.

Executives in the startups themselves are sweating a bit, said Suissa, because they need the capital to underpin growth for the next two years without having to tap expensive financing options.

He said the days of private capital willing to commit money at implied valuations that top 100 times revenues are over. That comes after years of “big money” and “dumb money” flowing into the private investment sector (and some of that came from VCs, he said).

Simply put: There aren’t that many great companies taking shape every year, and the VCs that have won, down the road and over time, tend to be ones with have focused, concentrated portfolios.

“If you’re just focused on playing the game in this comparative, competitive nature of the valuations, it doesn’t get you very far,” Suissa said.

As private investors step back and recalibrate their long-term strategies, many are finding success where VC meets D.C., at the intersection of technology and policy. And at that intersection, he said, volatility meets opportunity.

For those firms that serve the public and private sectors, with a tech twist …

“Think of them as baby Microsofts and not baby Lockheeds,” he said. The public sector tends to be just one of many verticals in which these enterprises operate.

The realignment of tech — and the payments aspects included in that tech — will succeed with artificial intelligence (AI), know your customer advances, and compliance (blockchain has a place here, said Suissa). Fraud prevention is an evergreen space, particularly with early-stage investments.

“Cyber is becoming part of a solutions approach,” Suissa said, “and supply chain solutions need to have security as a feature.”

He pointed to holdings such as Databricks, a data analytics firm that he said is expected to be among the biggest tech IPOs ever, slated for later this year. That company, he said, operates in several verticals, including the industrial sector, health care and the public sector. In another example, he cited SentinelOne, which went public late last year and counts the public sector as one of its most significant top-line contributors.

“These are all enterprise technology firms, he said, where the public sector and the commercial world are both customers.”

As to whether the exposure to those diverse top lines outperforms the relative volatility of the market, Suissa said that these commercial/public sector firms have some key defensive characteristics.

Defense in Productivity

One of the key defenses lies with productivity, no matter what an observer’s (or would-be investor’s) views of a recession or post-COVID or inflationary world. Enterprise technology providers, he said, offer their clients the chance to log higher operating performance with lower costs.

“The combination of those two factors will always be appealing in times like this,” he said. And, he noted, the public sector is counter-cyclical. When the private sector has bumps in the road, the public sector spends more money. That means the companies in SineWave’s portfolio can survive and thrive even in turbulent times and even when IPO windows close for a bit.

Drilling down a bit, he said that the investing team at SineWave remains thesis-driven, which means mulling the future of cybersecurity, of 5G and of the connected economy. He said that differentiated technology is critical, as are sizable, addressable markets. The executives at these targeted investment firms need to be flexible and forward-thinking.

“We do look for a profitability model and the ability to get there,” he told Webster,” even while we’re prioritizing growth.”

VC investments from SineWave, he said, can help these companies build their technology business strategy on the commercial side of their operations, targeting $100 million revenue streams that can, in turn, support a $50 million public revenue stream.

“If we can do that,” he told Webster, “then we can see some outsized returns.”

In the immediate investing climate, he said, there’s been and will continue to be a slowdown in venture funding — especially from investment outfits focused on later-stage investments finding sky-high valuations unpalatable.

Regulation Remains a Positive

And getting a bit more granular on the exit strategies that appeal to the businesses (and their backers) that might not want to go the traditional IPO route, acquisitions may still be a viable option — even with the somewhat nebulous regulatory environment that exists here and in Europe.

Some of the new regulations looming on the horizon can lead to standards of operation and conduct for tech companies — and transparency too, Suissa said. Those regulations will force firms to do more than pay “lip service” to serve the greater good.

“If companies adopt those standards and act more often in the public and commercial interests at the same time, the acquisition environment becomes a lot easier,” he said. Another viable strategy is hiring, where firms can poach talent from competitors in their bids to get bigger.

Over the next few years, he predicted, the venture capital ecosystem will contract, and the investments that stick around will become more concentrated. The free-for-alls where the same capital chases the same players, driving up valuations, will become a thing of the past.

“The high valuations are going to have to contract,” he said, “and for those of us [VC firms] that are alive and performing, there will always be money to raise and new opportunities. There will discipline for the investors and the startups, and those will be good things.”