Somehow June is over in just a few hours, meaning that we are trotting toward the third quarter’s starting line.
Leaving aside the uncomfortably rapid pace at which time is flying past us, entering a new financial reporting period is an excellent moment to pause, reflect and work out the key questions for the upcoming quarter. After all, we’ve seen so very much change on a quarterly basis lately that each quarter feels like a year.
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Recall Q3 2021, for example. After a lighter second quarter, the IPO market regained its footing last July, forcing this column to group public offerings into batches to just stay on top of them. And then Q3 set a huge record in terms of total venture capital investment to boot. Robinhood went public. It was busy.
The final quarter of 2021 was different. Seeing both the peak of many technology company valuations and their initial descent, Q4 of last year was a liminal state between the tail end of a long-running bull market and a rearing correction. Q1 2022 continued that trend, but with more bear than bull, and the second quarter — though we have yet to collect all the data — featured a moribund IPO market, rising startup layoffs, a crypto winter and more.
So what will Q3 2022 bring for global startups? Let’s talk through what we’re tracking, expecting and perhaps even dreading.
As we are on the cusp of a Friday before a long weekend, I know that you mentally have one foot on the beach. I promise that we’ll be brief today. Let’s talk through the three questions we have for Q3:
Will valuations recover?
For a brief period in the final weeks of Q2, it appeared that software stocks were mounting what could have been called a modest recovery. The Bessemer Cloud Index’s ETF closed at 25.93 on June 16, before ticking up to close at 31.21 on June 24. That bump did not last.
Since the little boomlet in software stocks, the same basket of companies is now down to 27.99 points, giving back the bulk of its gains. As the ETF traded as high as 65.51 in the last year, the recovery was modest at best. That it was also transient feels nearly rude.
But what matters is that as we head into Q3 2022, software valuations are in a trough. A critical question for the coming quarter, then, is whether those same companies can recover lost value. Earnings will play into this question strongly — so, yes, we will cover many a report in the coming weeks — but also the pace at which interest rates rise and more. The value of software revenue is not based on a single factor, which makes it hard to predict.
That said, if software companies fail to recover some of their value, the pressure that their depressed pricing has placed atop the shoulders of startups will not lift. And if that happens, many startups could find themselves between a down round at best and closure at worst.
Will private-market investment continue to slow?
Tied neatly to the valuation question is what VCs do in Q3. Notably, when startup prices are hot, private-market deal-makers buy more. When they are low, they buy less. Sure, that sounds backward — and very well may be — but it’s also a fact. For example, during the 2021 peak of the last startup boom, investors were paying record prices (in revenue multiple terms) in record amounts to a record number of companies.
Now that the asset class in question has seen its value dip, those same investors are pulling back. Again, you can fault the logic, but paper returns are one hell of a drug. Regardless, if the valuation climate does not improve, there’s little reason to expect the current negative drift in venture capital to change course.
On the other hand, if valuations of key public comps to startups do regain some lost ground, we could see a much more active venture market, leading to more deals, higher prices and a grace period for unicorns still nursing 2021 hype on their cap table.
Will troubled startups be offered lifelines, bailouts, mercy killings?
Even if things improve somewhat on the valuation front, and therefore on the venture capital side of the startup market, many young technology companies will remain troubled. What happens to this cohort of the startup market matters because it has raised ample funding to date and employs a wealth of human capital.
For startups with too much burn, too little revenue or simply a mismatch between their maturity and their last private valuation, options aren’t going to be pretty. A few things are on the table: First, some startups might get lifelines from their backers at flat pricing or thereabouts, allowing them to survive into 2023 and perhaps a stronger fundraising climate. Alternatively, some may be offered more expensive capital in the form of down rounds, recaps and the like. Finally, some startups might manage a fire sale to another company, large or small.
As capital raised in 2021 runs short, how frequent each option becomes is going to prove fascinating, at least from an academic perspective. For the humans impacted, it’s a more visceral question.
The public markets are not the only factor that drives sentiment in startup land, but I do think that the last six to nine months have taught us that the link is not just real — it’s material. As a final thought, perhaps all the above is too negative; maybe things will be better than expected, yeah? I am not in a particularly optimistic mood lately, but what do we know? The data starts rolling in tomorrow.