What connects the stock market contraction to startup valuations?

In an analysis of the market, Justin Kahl and David George of Andreessen Horowitz showcase data on how public companies have seen their revenue multiples shrink by an average of 60%, with large sector variability.

They use this central data point to suggest how startups should navigate the downturn, with the primary objective of climbing back to their previous valuation. But are valuations really down? For all startups? If so, why, and what can we expect in the short and mid-term?

What connects stock market contraction to startup valuations?

Startup valuations are only loosely connected with the stock market. Risky, early-stage companies acting on a non-significant number of customers have little correlation with the bigger picture. However, there is still a link, and it is worth analyzing.

Valuations are, or should be, a reflection of risk and return. These parameters are only slightly affected by the erratic and unpredictable behavior of the stock market. The main factors affecting the sell-side (startups) during a market downturn are greater difficulty in closing enterprise customers and lower likelihood of a large exit through a corporate sale.

But when we look at the buy-side, things are more dramatic, which explains why lower stock prices are a more pressing concern for investors than for startups.

Startup valuations are only loosely connected with the stock market.

On the buy-side, the companies that invest in VC funds generally have their shares traded on an exchange or are a pension or mutual fund, which see the value of their holdings diminish significantly due to lower share prices.

This is the most critical impact of downturns: Venture capital funds will have a more challenging time raising money to invest, which translates into less capital being available to founders.

However, it will take months (probably up to a year) to see the impact of this on the startup market.

Of course, knowing this, VCs will adjust their portfolios and try to invest less per ticket in the hope of benefiting from being the only ones with available capital when things get tight.

Let’s take a second and look at these two sides in depth, starting with the buy-side.

The buy-side

Corporate venture capital

The first money that disappears as stock prices fall is that of corporate venture capital. Already under pressure from shareholders, public companies will withhold long-term bets on the startup sector.

Source: TechCrunch

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