Jodie:What current VC trends excite you and which cause you concern?
Steve: One of the things that excites me the most is a return to fundamental business building.
Resets and valuation downturns are painful. We’ve always been a cyclical business and we always will be. In down cycles, the old rules that govern commerce come back into play – meaning that you don’t just buy growth at all costs. You invest intelligently, keep customers happy, grow revenue, amortize costs over a bigger base and become profitable.
In technology, the markets give you a lot of leeway, because you’re doing something new – you’re creating a new market. Investors don’t ask you to become profitable right away. But eventually you must be. I think we will be able to run companies in a more responsible fashion than when you run them and say, “Whatever we spend, somebody will pay a higher price. So, let’s just keep spending.” That’s what was happening in 2020 and 2021 – and in other bubbles. I witnessed it in 1999 and 2000.
In the short term, it’s going to be painful – hard on liquidity, more down rounds, more rationalization of business, more mergers & acquisitions – all of that will take place. But it is going to be better for a company’s long-term health.
Other technology trends that are big include security, which is a big focus of mine. I’ve backed CrowdStrike, Anomali and Traceable, among others. Cybersecurity is a never-ending battle between offense and defense, and we need to secure data and protect it.
Another is infrastructure, which is always changing. How do you use open source effectively in commercial applications? What is old and not meeting the needs of current customers? What infrastructure is going to support AI most effectively? That’s an area where we’re spending time.
Jodie: What business advice do you most often give companies about fundraising?
Steve: I really like to ask the “use of proceeds” question.
If you raise a new round of capital, let’s say it’s $30 million or $40 million, and you’re at a certain point in your business, I like to ask, “What will this additional capital do for you? How will you use it? What will this company look like before it raises its next round, either publicly or privately?”
That tests their command of the business, shows how they will use capital and clarifies what the business should look like before it raises again. And it gives the venture capitalist confidence that the next round will be north of the current price they’re paying.
If someone can’t answer these questions, and they don’t know what they’re going to look like, but they’re driving a high valuation and they don’t have much revenue, that raises some flags for us. Because if they take your capital and use it inefficiently, then they’re going to come back to the market, and somebody’s going to say, “I can’t get to the price that IVP just paid.”
That’s the way venture capital has always been done responsibly: You raise capital, you invest it, you build your business and mitigate risk over time. By the time you go public, you can give guidance, and public investors can say, “OK, I understand, that’s a fair price. I’m going to buy into this company.”
And then you meet and exceed that guidance. That’s how you create value for everybody.
Jodie: VC financing started to rebound over the last quarter, as did the percentage of down rounds. Is this a fluke, or do you see further quarterly increases on the horizon?
Steve: I think you’ll continue to see the number of deals increase – meaning that companies that raise those rounds are starting to exhaust them, and they’re going to need to raise money at some price.
I think you’re also going to see the number of down rounds increase. Companies may be low on cash, they’ll need new capital, the last price was too high, they made progress but not enough to exceed the last round price. So, they’re going to raise money, but they’re going to have to take terms or a down round – or a flat round, if they can pull it off. The really great companies will still be financed in an up-round valuation, and I think that will be the rationalization of the financings that took place in 2020 and 2021.
The difference between other cycles is that – although the tourists have left, as they always do when markets contract – the consistent venture practitioners raised a lot of money that will eventually need to find a home. They must find a way over time to put that capital to work so it’s not going to cause the complete collapse of valuations, but people are going to be very selective.