Despite the economic backdrop, startups continue to plow ahead. One of the biggest changes in the last year in the US is the Fed’s stated low interest rate policy for the next three years. What impact are we seeing in the market?
Theory says lower interest rates means investors should shift from less risky to more risky assets to find the same level of return. If the government lends at a low rate, then the cost of capital is less, so companies should be able to invest more at the same cost, and grow faster.
We should expect four outcomes:
- More money should enter venture capital funds. These are new dollars looking for yield.
- We should expect an increase in the valuations of rounds. Fast growing companies should be more valuable first because the demand has increased for their shares, and second because it’s lesse expensive to grow at the same rate.
- IPOs and M&A should increase because public market investors would like access to high-growth companies and acquirers would like to benefit both from their elevated valuations to buy companies with more valuable and demonstrate higher growth on their P&Ls.
Let’s go through these one by one using the Pitchbook Venture Monitor Report.
VCs have raised $57b through Q3, implying $75b for the year, a total which would eclipse any other year in the last decade. And it would be 4x the size of 2010. Check.
The late stage venture market is on pace to set a record in 2020. Through Q3 2020, late stage investors have invested as much as the entirety of 2019, and should things continue linearly we should expect the final tally to exceed $100B. More dollars chasing higher growth, higher yield, and riskier investments.
Also, the valuations of the top companies have more than doubled in an year from about $300m to $672m. When demand exceeds supply, prices increase.
And we know from a previous analysis that the public markets price high growth B2B companies at more aggressive prices than the private markets. Check check.
Last, 2020 is on track to set a record for total IPO proceeds in a year. And that doesn’t include Wish, Affirm, C3, Roblox, and AirBnB, who all filed this week. Check on IPOs.
And prices of all exits (IPOs, buyouts, and M&A) have all increased with IPOs seeing the most appreciation.
For founders and investors, a low rate policy charges an already frenzied environment further. Prices are higher, investment rounds larger, exits more valuable. And who knows where we’ll end up if rates do remain this low for another 2-3 years?