How the tech bear taking a bite out of FAANG stocks affects venture capital

Have the FAANGs been unfanged? That’s how it feels after Facebook, Amazon, Apple, Netflix and Google (FAANG) collectively lost more than ₹70 trillion in market capitalization since scaling the peaks in mid-2018. The sell-off will have far reaching impact for start-ups looking to raise capital, illustrating an underlying truth behind the forces that combine technology and capital.

How the tech bear taking a bite out of FAANG stocks affects venture capital

The reality is that public markets and the private investment ecosystem are locked in a self-reinforcing dynamic; that’s because public markets are the exit for venture capitalists whose early investment in a start-up envisages such an outcome.

This US stock market bull run has been one of the longest in decades driven by technology, which has attracted more capital to venture capitalists who in turn have been fuelling innovative tech companies to raise capital, encouraged by higher valuations at each stage. Even Amazon and Netflix rely on public markets for funds to fuel growth.

So what happens now?

It would be easy to dismiss the recent market correction as a short-term blip, but that would be to misread the development. Such corrections often reflect either one or a combination of a slowing world economy, trade wars and a bottoming of the current low interest rate cycle in the US. As risk-free capital becomes more expensive, investors seek higher and safer returns in other asset classes.

The implications for those raising venture capital are real.

First, the already lengthy process of raising capital could take even longer, with no certainty of outcome. Venture capitalists tend to delay decisions on new investments because they themselves are raising new funds, either from wealthy individuals or professional investors where caution has also set in now.

Sector-specific valuations are a second concern. In e-commerce, there may be more investor scepticism, given the backdrop of Amazon and its challenges. In social media, there is a wider set of issues overhanging the business model—privacy and data protection and how data is used. However, valuations in ‘deep-tech’ such as artificial intelligence, machine learning, cybersecurity, blockchain and internet of things, are likely to continue to be robust.

Amid these anxieties, the entrepreneurs’ dilemma is how to raise enough capital to grow the business to the next milestone, while minimizing dilution for existing shareholders. Higher valuations make it easier to balance this dilemma, while lower valuations pose challenges, such as whether capital can be raised at all from the market.

The key to fundraising in such a volatile market is unfortunately to raise more than is required so as to provide enough runway for the start-up to grow before returning to the market for more fundraising. This will always be more expensive as capital is being raised at a lower valuation to secure a further runway for the business.

Today, the FAANGs, with the exception of Alphabet (Google) are in bear territory. Amazon’s founder Jeff Bezos told his staff that “one day Amazon will fail”. Are US stock markets saying that this event could be sooner? Can we really imagine a world without Amazon? In times such as these, start-ups must invest in communicating the uniqueness of their business model. Setting themselves apart from the noise of the marketplace will earn the ear of the right venture capital investor who brings patient capital and that may be the difference in riding out the peaks and troughs of capital raising.

source: livemint


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