we are in very interesting times today. It is rare to see so many tectonic changes in real time: high interest rates, declining stock values, SVB and other banks fail with continued contagion risk and impending recession.
There has been an aggressive shift in the assumed returns of equities compared to the returns of fixed income. The data tells a clear and extreme story.
Simply put, equity risk premiums (ERPs) have broken out well below the ranges that have been established since 2008. The ERP calculates projected S&P returns versus 10-year Treasury bill yields (data of Morgan Stanley).
The chart below is important to the startup audience because it explains why fundraising is extremely challenging right now and why valuations are falling so dramatically. The opportunity cost is really powerful.
For the risk world specifically, this dynamic is compounded by cooling risk debt markets, which in turn makes equity the more viable option for most.
Image Credits: Irving Investors
The factors at play
Waiting for a bounce in public market multiples to preserve past valuations has not proven to be a good strategy.
Venture capital activity has declined
The deployment of venture capital continues to slow. SVB measured the inflow and outflow of deposits by a metric called total customer funds (TCF), which has been negative since the first quarter of 2022 (five consecutive quarters now).
This trend continues in 2023: VC deployment is down another 60%, and deal counts are down about 25% from the prior year.
The decline in venture activity combined with the fall in ERPs is a clear sign that there needs to be a material correction in valuations for private technology companies. Anecdotally, however, we have seen that valuation expectations for private companies have remained high relative to obvious public comparables.