ESO's Monthly Start-Up

July 2023

First Half ‘23 Recap

In the public markets, we have seen a first half rebound from Fall 2022 lows with the S&P500 being up 15% YTD. This uptick is led by a tech heavy run as seen in the NASDAQ100, which is up a whopping 38% YTD. This increase has been led mostly by the surge in hot “AI” stocks.

The early public tailwinds have yet to hit the slower moving private markets, as startup valuations (with the exception of AI) are still taking their medicine coming down from the bull market highs. As companies continue to raise funds in this new environment, both founders and early investors are finding it to be a highly investor-friendly market.

Per Pitchbook, companies are often forced to seek out highly structured funding in lieu of simply raising capital at a lower valuation (aka a “down-round”). In order to warrant paying a similar price to those paid in 2021, investors are adding extra terms that were not commonly seen in the hot fundraising-friendly market most companies last raised in.

With interest rates up and multiples down, investors are looking for protective terms to de-risk their investments and justify paying a slightly higher price to keep the founders/early investors appeased.

Some examples include:

  • Liquidation Preference Multiples: A Liquidation Preference is an investor’s right to get their money back before any money goes to common stock, as a way to balance their risk. In previous years, nearly all funding rounds featured a 1x Liquidation Preference (aka investors guarantee 1x their money back before any funds go to common stock). In today’s environment, many investors are requiring Liquidation Preferences of greater than 1x (as high as 4x their money). According to Pitchbook, Liquidation Preferences above 1x accounted for 9% of all deals in Q1 2023 compared to less than 2% in Q1 2022.

  • Stacked Preferences: On top of higher Liquidation Preferences to lock in a better return for investors, they are also asking for preference over previous investors. In a hotter market, investors typically buy in “pari-passu” meaning all preferred stock is treated equally in a liquidation event. Today, many investors are asking to get their Liquidation Preference back before any other preferred stock in an exit event. This poses a tough term to swallow for many prior investors / board members of companies who stand to be pushed to the back in the preference stack.

  • Cumulative Dividends: Pitchbook also mentions a rise in cumulative dividends from 17% in 2021 to 26% in 2023. This simply means dividends that were not typically a factor, now accrue over time and can be tacked onto the Liquidation Preference at exit time.

  • More board seats: More board seats for new investors means that in addition to the equity they have in the company, they also will have a bigger seat at the table to influence the company going forward.

All this to avoid a down-round? With prices down across the board and leverage firmly in the hands of the VCs, companies must either take a lower valuation or add some hair to their cap tables - or worst case, both.

Many companies that raised large funding rounds in 2021 have taken cost cutting measures like layoffs to lengthen their runway. They have kicked the ball down the road for now, but as 2023 ends and we head into 2024, most of the companies will be forced to raise additional funding unless the IPO markets open up. Their hope is that multiples expand some in the meantime, and the recent run in public tech stocks provides a modicum of hope.

Speaking of IPOs, the market remains relatively dry. After RECORD SMASHING years in 2020/2021, things came crashing down to Earth in 2022 and have yet to pick back up (although we have slightly more momentum than Q4 of 2022).

All IPO data per stockanalysis.com

It doesn’t take a seasoned statistician to see that 2021 was a year of unprecedented liquidity. Of the 1035 IPOs in 2021, 627 were SPACs (a subject for another day…) and the remaining 408 traditional IPOs are down an average of 43% since their initial offering. This is compared to the S&P500 which is down 7.5% since Dec 31, 2021.

With the IPO doors remaining shut for the time being, most companies will either be forced to raise again or fold. We addressed the state of the fundraising climate above and the Wall Street Journal wrote a great piece on a possible culling the of startup landscape to come in 2024 (WSJ article). Either way the fate of many companies including the 1,200 unicorns worldwide (per CB Insights) may well be decided over the next 6-18 months.

Tips of the trade

No “Tips of the Trade” this month with the extended intro, we will be in August with more savvy stock option info!

Financing your option exercise can be expensive and a require a large capital outlay. Feel free to reach out to us to discuss your options for partnering with ESO to exercise your options risk-free.

The ESO Fund does not provide legal, financial, or tax advice.

Layoffs Stable Into July

Layoffs for June are at a similarly low level to where they fell to in May. While the total number of employees laid off in June declined by 29%, the total number of companies that experienced layoffs saw an uptick of 15%. This may mean larger players having already taken their medicine and now smaller companies are following suite. Total layoffs for the month were led by Bitwise laying off roughly 900 employees, and Grubhub letting go of 400.

Why this matters: As many startups continue to face a challenging funding environment, preserving capital has become critical. As such, layoffs become a natural byproduct. Companies trying to reduce their G&A expense may initially turn to layoffs of noncore employees such as those in recruiting or HR, followed by more core roles if the finances dictate such a move is necessary. The uptick in the total number of companies with layoffs in May points to smaller companies finally having to bite the bullet in order to keep operations going. If the tight funding market continues for the rest of the year, we do not expect many changes to this trend.

Brought to you via layoffs.fyi

Secondary Market Sentiment: Door to liquidity remains shut

The graph below displays the ratio of buyers vs sellers for a given month on the private secondary market. Months with more buyers than sellers are displayed in green while months with more sellers than buyers are displayed in red. All data pulled from Zanbato, the below list does not imply completed transactions, simply intent to either buy or sell shares.

Secondary sentiment remains fairly entrenched in the red, though it appears transactions are getting done. We will see if the recent upward trend in public tech stocks kicks the market into gear, but for now this likely hinges on a more robust IPO market. Just like companies trying to fundraise, unless your website domain is “dot AI”, you are looking at punitive terms when trying to sell your stock on the secondary market.

Public Multiples Check-in: "Yesterday's Price is not Today's Price"

Multiples have continued to recover after months of steep declines year over year. Five out of the seven sectors that we are tracking have seen increases in their forward multiples compared to this time last year, pointing to a more bullish investor sentiment going forward. Notably, Enterprise SaaS and Real Estate multiples continue to trail their previous forward multiples from last year.

Why this matters: The real estate sector has continued to get knocked by the high interest rate environment, and with both Airbnb revenue collapsing and the commercial real estate sector starting to show some cracks, there’s a lot of uncertainty here that is impacting forward multiples here. We expect continued trouble here as people shy away from the sector due to affordability issues.

June's Top Ten:

  1. Reddit has had quite the month after announcing that it would be charging fees for developer access to its API. The change comes as Reddit is seeking to increase its profitability ahead of an eventual IPO. The change has resulted in some major pushbacks, including a Reddit blackout earlier this month in protest of the new policy.

  2.  Inflection AI, the year-old startup behind Chatbot Pi, had the third biggest raise of the year this past month, bringing in $1.3B at a valuation of $4 billion. The round was led by Microsoft, Nvidia, and billionaires Reid Hoffman, Bill Gates, and Eric Schmidt.

  3. While generative AI has been the major fundraising focus of 2023, cleantech has continued to see investment, most recently with CleanCapital raise of $500 million led by Manulife Investment Management. This is CleanCapital’s biggest funding round for the eight year old company that focuses on middle-market solar and storage.

  4. Databricks is getting serious about competing in the AI space, and this past month, announced it will be paying $1.3 billion for two year old artificial intelligence startup MosaicML.  At 65x revenue Mosaic’s $20M ARR, it’s a big bet.

  5. Old rivals faced off again this month in a battle for PointsBet’s U.S. assets. Fanatics initially started the bidding war with a $150 million offer, only to be countered by DraftKings at a $195 million cash offer. Ultimately, Fanatics raised the stakes once again, upping the price to $225 million.

  6. Real estate technology is continuing to struggle, as PeerStreet, a platform for investing in real estate debt, has announced that it has filed for Chapter 11 bankruptcy. The company last raised a $60 million Series C round led by Colchis Capital in 2019.

  7.  Late stage valuation and an overall slowdown in exits is continuing to put some pressure VCs, as showcased by Tiger’s latest endeavor to achieve some liquidity. The investor has recently failed to find a buyer for a large basket of its stakes in private tech companies, and has most recently started trying to sell individual stakes of its portfolio companies. The current liquidity crunch is real in the VC market right now.

  8. Some brighter news for the ecosystem, Cava made its public debut on June 15th , and shares after its opening day closed at $43.30. This is almost twice the $22 per share price tag a day prior. The price has held up, with a closing price at the end of the month at about $40 per share.

  9.  In additional IPO news, Reuters’ reported at the beginning of the month that Rubrik Inc, a U.S. cybersecurity software startup backed by Microsoft Corp. and valued at $4 billion in a fundraising round two years ago, has hired banks for an initial public offering. The news continues to support the sentiment that the IPO market might start heating up again in the near future.

  10.  Newly minted unicorns have become an increasingly rare species as valuations have been brought in and funding has dried up in the current economic environment. However, Cart.com, an Austin-based end-to-end ecommerce startup, raised a $60 million Series C round this month that pushed its valuation to $1.2 billion.

Why this matters: Cava’s IPO success is great news for companies seeking to go public that have been sitting on the sidelines for a while. We have been seeing more and more late stage start-ups either hire bankers to start the process for reaching the public markets, or continue to extend their filings to IPO. The dam hasn’t quite broken open for new public listings, but we are finally starting to see some cracks.

Startups that are still hiring!

Open positions are per the company's website.