Calling all LPs! Thanks for joining me (John Bailey, Co-Founder at OneFund) for another edition of Capital Call. A bi-weekly private equity newsletter from LPs for LPs. 

The mission of Capital Call is to deliver concise, top-notch insights and updates from the private markets tailored to what matters for LPs. 

This week we will be looking at: 

• The Resurgence of Early-Stage VC

• Fundraising updates and VC/PE reports

• GP Perspectives from Daniel Murphy & Chamath Palihapitiya

VC Valuations Continue Downtrend, but Seed Markets remain Steadfast

Venture capital has faced continuous challenges in fundraising, valuations, and exits this year, but Pitchbook’s latest VC report finds that the pre-seed and seed markets have remained resilient and even excelled in Q3. Early stage venture’s formulaic deal-making, focus on qualitative due diligence, and abundance of smaller VC funds that closed in the past year are allowing companies to continue to raise.

In this week’s capital call, I’ll analyze the renewed strength of early-stage VC and how that impacts LPs.

Early-Stages Remain Insulated from the Liquidity Crunch and Macroeconomic Volatility

This chart is pretty insane. For all the doom and gloom about valuations over the past few years, we see median seed pre-money valuation reached a record $12.0 million in Q3, along with median deal size reaching a record of $3.3 million.

The abundance of new, early-stage funds leads Pitchbook to forecast strong seed-stage deal metrics over the near term but warns of long-term issues if they perform poorly and a substantial number of them fail to raise another fund. This is something that likely will happen as we’ve seen a fundraising flight to larger funds in recent years.

Later-Stages Expected to Hit Record Lows

Q3’s late-stage deal numbers show a stark contrast where valuations declined moderately and are now down 22.4% from 2021’s record year. Personally, I view this as an opportunity for late-stage/expansion-stage venture. Sure it isn’t good now, but these investments are long-term and one must look at the 10-year horizon when evaluating a fund.

This is driven by the most successful late-stage startups avoiding raising pricey equity financing in today’s less favorable environment. They have long runway and are planning on using it hoping for better terms down the line.

As a result, the companies raising capital in the late-stage market are those forced to return to market due to low cash reserves/revenue streams and are unable to sustain capital requirements. These companies will attempt to minimize the capital they raise to avoid the harsh valuations given, further limiting market size.

That doesn’t necessarily mean these companies are low quality, however, and investors may be able to find quality late-stage startups at a bargain.

In addition, the reluctance to raise equity financing may open broader opportunities for GPs and LPs to step in and become capital providers in other structures, such as convertible notes, credit, and bridge rounds in the late-stage market.

Updates from Across the Ecosystem

Fundraising

📈 Carlyle Spinout Stellex Targets $2.5bn for 3rd Special Situations Fund

📈 Georgian Raises $1.4bn for latest Flagship Tech Fund

📈 SEVA wraps up Inaugural Fund at $85m

Reports

🔬 KKR: Flash Macro U.S. Jobs Report

🔬 Bain: Global Venture Capital Outlook

🔬 Morgan Stanley: What is Tax-loss Harvesting?

GP perspectives:

Daniel Murphy (Head of Alternatives, Goldman Sachs Asset Management)

Goldman Sachs believes that private equity will have advantages compared to public market investing when it comes to large-scale company transformation as trends from technology, interest rates, and sustainability disrupt the corporate world. However, Murphy believes private equity strategies are rapidly changing amid higher-for-longer rates in GS’s latest report, with a specific emphasis on tech investing.

Technology isn’t a “stand-alone thesis” for higher returns, according to GS. New advancements in data science, AI, robotics, and automation are providing tools for large-scale enterprise transformation, but these novel technologies will eventually become a requirement rather than a competitive advantage. 

Therefore, tech GPs will need to not only build a first-move advantage but also a defensible moat. They also must underwrite realistic views on the technology’s ability to expand or create new markets, rather than assume tech alone will sustain returns. 

Capital deployment must be strategic, as pursuing tech initiatives will mean spending significant capital now while rates are high to achieve benefits that will potentially be realized far in the future.

To benefit from these upfront capital investments, GPs should extend holding periods or find ways to execute faster on timelines. Closer collaboration between the GPs’ investment and operating teams may be required to speed up digital initiatives. 

Overall, technology alone will not shield GPs in the space from facing broader macro headwinds, but they will benefit from a long-term time horizon that enables iterative pivots and adjustments as necessary, along with more efficient governance models.

Chamath Palihapitiya (CEO, Social Capital)

Chamath, CEO of Social Capital, complements the previous insight that advanced technology, such as AI in this case, does not generate higher returns on a stand-alone basis. The AI industry appears to be funneling billions towards capex spending with not much to show for it in terms of revenue generation.

He hypothesizes AI will have to create real value either through opex savings or hope AI startups achieve product-market fit that allows for recurring revenues. If the case for AI is the latter, the industry could see a sharp reversal if product-market fit isn’t achieved.

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