The heyday of venture capital fueling innovative technology companies is far from over.
HarbourVest Partners argues the tough environment of the last year ultimately will offer investors a better entry point, particularly in fintech and artificial intelligence.
“I think there are business cycles and economic cycles that you can correlate to private market performance. But for venture capital in particular, the cycle that matters the most is the innovation cycle,” Scott Voss, a managing director at HarbourVest, told Institutional Investor.
Today’s tech era is ripe with innovations in fintech and AI, where advanced platforms and business models allow new players to enter and challenge incumbents.
“We continue to see fintech as an expanding market segment. The Industrial sector has seen a boom of innovation given a highly fragmented global supply chain and legacy systems that struggle to work together,” wrote Voss, in a written commentary. “Automation and AI provide a universal set of tools to improve existing processes. We see these applications used across industries on everything from talent recruiting to cyber security to drug development.”
The price corrections in the tech sector shouldn’t surprise investors.
For the past two years allocators have been investing at the top of the market. In the next 12 to 24 months, Voss expects prices to become more rational, with investors getting access to high-quality companies based primarily on realistic financials as opposed to inflated growth projections.
“Leading up to the downturn in 2022, there was growing speculation...in both public and private markets. It was move away from fundamentals – growth, profitability, cost of capital, duration, etc., which makes sense when interest rates are zero and money is effectively free,” wrote Voss. “Now that we are moving into a more normal interest rate environment, valuation methodologies will more heavily weight fundamentals.”
It’s a reflection of what’s played out in the public markets.
“Amazon became the first company to lose a trillion dollars in value ever,” Voss said in the interview with II. “And Amazon is still a market leading and market defining firm, but how you value its future cash flows has changed because the discount rate has become greater.”
Investors can expect to see declining valuations in the private markets, albeit with a lag, where the adjustments are applied quarterly. But a mark to market criterion shouldn’t be the only reference point, according to Voss, who says it is difficult to compare private companies to their publicly-listed peers when day-to-day volatility is so high.
“We believe private equity [and venture capital] should not try to time the market, which is in line with the logic we apply when making investment decisions,” wrote Voss. “We diversify our portfolios over time just as we diversify our investments by strategy, industry, geography, stage, and size. This strategy moderates systemic risks associated with poorly-timed investments, making overall portfolio investment performance more dependent on each manager’s experience, investment selection, and ability to add value.”