Fear of missing out
Sticking to fundamentals despite a hot market
Happy Thursday,
During 2021 deal activity in the venture capital market increased over two times from the prior year, and activity for the first half of 2022 is about equal to the full year 2019. When markets have this significant of an increase in activity, investors and companies tend to disregard fundamentals and chase returns for fear of missing out on opportunities.
Media Viewpoint
About two weeks ago the Wall Street Journal published an article titled “Tech Downturn Slows Early-Stage Startup Funding”. There have been similar articles published over the past few months but the timing of the Wall Street Journal article along with release of mid-year industry data provides a good reason to dig a bit deeper into what is happening.
The article discusses the funding slowdown but it was the below quote which highlights the challenges of sticking to fundamentals despite record activity in the broader market.
investors say even the youngest startups are now being expected to demonstrate they have a clear path to generating revenue and profits. Such metrics weren’t always given priority by investors looking to back new, buzzy companies last year as a record amount of capital and low interest rates fueled a race for returns
The 2020 – 2021 venture capital market was a period where companies with no business plan or questionable strategy could raise considerable funding. Capital flowed into the space as investors were seeking higher return opportunities and often invested after only a single meeting or sometimes without even meeting a company. We also saw a number of companies turn to crowdfunding as a way to quickly raise money as in March 2021 the SEC allowed companies to raise $5 million annually, up from a prior limit of $1 million.
During the past few years investors had to be careful about not getting caught in a fear of missing out on opportunities and disregarding fundamentals. Earlier this year we wrote about why its important to write an investment memo as it provides an external reminder to remain focused on fundamentals and not invest purely on emotion.
2022 Deal Activity
To put framework around the market activity, as of mid-year 2022 deal count and value both had their third consecutive quarter of declines. Recent media articles about a declining market tend to focus on the short term shifts but when evaluated against the past five years the market remains well above average activity levels.
The fear of missing out on opportunities can also work in reverse as investors reading headlines about the venture capital space might assume the market is significantly impaired and decide to stop all investing activity. Evaluating macroeconomic trends based only on a few quarters of detail is not ideal as when considering a longer timeframe it becomes evident the current market activity remains above normal and may just be returning to a more normalized rate of growth.
Investing in startups or small company ventures requires a long term perspective, so the same should be considered when evaluating the broader market. Sometimes it helps to step back and look at the historical market trends as a way to recognize when the fear of missing out replaces fundamental decision making.
Thanks for reading and hope everyone has a great weekend!