Market volatility is expected to remain elevated for the remainder of 2022, with global monetary policy tightening expected to continue, despite the rising risks of a recession.
This type of environment can make navigating markets inherently difficult. The following aim is to provide an overview of some of the key trends seen on AIM and in the venture capital market so far this year, along with some considerations on the outlook for this space as we head into the VCT fundraising season.
- High valuations coming into 2022 led to a number of strong exits in the ventures space across 2021 and the start of 2022 (e.g. Interactive Investor, Cazoo). However, a lot has happened since then, with the substantially increased inflation expectations and subsequent tightening in monetary policy, supply chain issues and not least, the war in Ukraine, there has been considerable downward movement in public market valuations. The VCT and EIS space is not immune to the events of listed markets, and we are likely to see valuation readjustments as the impairments seen across public markets begin to spill into the private market space, particularly for later stage companies approaching exit.
- Increased public market volatility has had a material impact on the IPO market, including that of AIM companies. Companies will broadly look to hold off listing until market volatility stabilises and positive momentum picks up. A reduced number of companies looking to IPO could limit the universe for investment opportunities for AIM VCT managers, at least over the short term. To caveat this, periods that cause delays to IPOs can lead to a backlog of activity, ready to be unleashed at a later period. What is worth noting is that volatility and difficult economic times can provide new opportunities for dealmakers, especially in the current climate, where many companies have recently completed funding rounds putting their cash balances in good stead to weather the storm.
- However, M&A activity could remain active due to high levels of dry powder (investable cash), and requirements for deployment. Trade sales are the most common means of exit within venture, so an active M&A and Private Equity market is an important consideration for the VCT & EIS market. Furthermore, the compressed valuations could provide opportunities for investors to access companies at more reasonable prices, especially when private assets are valued against public market equivalents (PME’s). It is worth considering that the compressing of valuations might be more muted due to high levels of dry powder available in the market, particularly when considering the levels of funds raised across the UK VCT/EIS markets through the course of 2021/22.
- The current macro environment should be conducive to high activity in certain sectors, such as tech-enabled cybersecurity, defence, and supply chain technologies. Healthcare companies such as pharmaceuticals, healthcare services and life sciences could also maintain high activity levels as a direct externality of Covid and existing outdated legacy systems in need of technological innovation. Importantly, many of the new companies in these sectors operate B2B – similarly to many of the companies in EIS and VCT portfolios. A result of higher B2B cash flow exposure is lower sensitivity to market cycles than B2C businesses, which should be more helpful to sentiment in the case of any oncoming recession.
- Large VC investors such as Tiger Global, D1 Capital and SoftBank have revealed a scaling back of VC deployment intentions for 2022, but increasing the proportion of investment to earlier-stage companies. Moving earlier along the business funding line provides opportunities for larger shareholdings in companies at better valuations. Earlier stage investments are often more insulated from the macroeconomic environment than later stage investments; however, they will come with an enhanced level of risk relative to later stage businesses.
There are market forces pushing valuations both up and down, as well as headwinds coupled with tailwinds for portfolio companies. While the mid-term macro-outlook is looking a little more troubled, the long-term nature of venture investing provides an opportunity for investors to ride the storm and could provide relatively cheaper access points to great businesses. So whilst the following year might be troublesome for valuation and exit metrics, there are likely still some material opportunities available.