ESO's Monthly Start-Up

May 2023

Let’s Make an (AI) Deal

We hope at some point we will be able to start this newsletter with stats on how the VC and start-up industry is booming, IPO’s are happening left and right, and things have never been better. Unfortunately, today is not that day. Stats for Q1 venture funding are out, and the results are lackluster. While Q1 2023 numbers are down just 1% quarter over quarter, Stripe’s $6.5 billion raise contributed heavily to the numbers. Without Stripe’s raise, funding would have declined by 21%. Deal volume also saw declines in Q1 2023, dropping 3% from the previous quarter. While 3% isn’t too drastic, the deal volume still marks the lowest levels since Q2’20.

With both deal volume and funding down, where are these deals actually getting done? The data points to two main places: Silicon Valley and Generative AI. While overall deals have slumped, Silicon Valley funding doubled in the quarter, increasing to $14.5 billion ($8 billion w/o Stripe). While venture has made strides to try to expand beyond the mecca that is the Bay Area, during the tough times, it looks like money is flowing to the place VCs know best. However, it appears that the sentiment of “everyone is moving to Texas” isn’t totally overblow. Among US metros, Dallas saw the largest QoQ jump in funding at 250%, while Austin saw 33% growth.

As we have mentioned in the past couple of newsletters, VC has found a new darling, and that is generative AI. Three of the top 10 deals for the quarter went to AI developers. Anthropic took two of these rounds with a $400 million corporate minority round from Google, followed by a $300 million Series B round. Adept snagged the 3rd spot, raising $350 million in Series B funding. It’s clear that 2023 will likely be the year of AI. However, it remains to be seen if something shinier will take its spot in the coming years (I’m looking at you EVs and quantum computing).

Why this matters: Start-ups are currently facing a difficult deal making environment where capital available continues to be sparse. The fact of the matter is that cash is more expensive now than it was during the party times of 2021, and VC’s are being more deliberate on their due diligence processes and where they deploy funds. Like most things right now, there is likely to be some continued uncertainty as we wait for the Fed to pivot from its interest rate increase mandates. Hopefully, the stability of no more rate increases will spur more deals in the industry.

Tips of the trade

A section where we provide helpful tips for anyone with stock options or shares at private companies.

Secondary Market 101

We talk about the private secondary market every month in this newsletter, so we thought it would be a good time to explain it in some detail.

What is the secondary market? This is simply a broad term for all the transactions that take place involving private stocks. The term secondary comes from the fact that shares are being sold by investors and employees to outside parties. The primary route to acquiring stock in a startup is to either work there, or invest directly in the company.

Where do you find buyers? Both buyers and sellers can be found on marketplaces like Forge, EquityZen, Zanbato, or Hiive. These examples are all brokerages that take a fee for every transaction. Interested parties can list either bids to purchase or offers sell including pricing and volume.

How do I know what price is right? This is the tricky part… when trading public stocks, the market is efficient enough that every stock has a trading price. Whether you should buy or sell a public stock based on its price is a separate question, but private stocks don’t necessarily have any reliable price data available.

The nice thing about the marketplaces listed above is that for many companies with active buyers and/or sellers on the platform you can get pricing data. However, buyers are often asking for low prices, and sellers look for high ones, while transactions typically take place somewhere in the middle of this bid/ask spread.

So let’s say your company does have pricing data, how do you use this to determine if you’d like to buy or sell? On the other hand, how do you come up with a price if there aren’t any active bids or offers? The most important number you can work off of in a vacuum is the last round preferred price. Most secondary transactions occur at some discount to that price (many platforms will even tell you “$X per share or a Y% discount to the Series D price” etc). Using the last round preferred price you can determine how much the company is worth at a different price per share values. Understanding what the per share price implies in terms of company valuation is the most important part of a secondary market buy/sell decision.

For any ESO Fund clients with opportunities to sell on the secondary market, your ESO Equity Partner will happily discuss how we think about these sales and what we are seeing for your specific company.

How is ESO different from the secondary market? At our core, ESO Fund is a secondary market participant (both as a buyer and seller). Our stock option exercise funding is much like a secondary sale for only a portion of the stock. We can even provide liquidity beyond your exercise amount to allow you to cash in.

The main differences are 1) ESO is a fund, so we are the direct counterparty. There is no broker involved. 2) We do not typically purchase 100% of the shares in a transaction, so you work with ESO to go long on your stock, not sell out today. 3). ESO transactions do not require transfer of share ownership.

It is possible to find secondary buyers that do not require shares to be transferred, but those buyers are few and far between in the current market (much more leverage in the buyer’s hands).

Overall the secondary market is still nascent in its existence, but as it matures, more and more folks turn to it as a route to pre-IPO liquidity. Especially with startups staying private longer and growing to rich valuations, the option of secondary market liquidity can take a massive weight off of employees who have large “on-paper” wealth tied up in private companies.

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 Slow in April

Layoffs have continued to slow from a peak in January. April marked the 3rd straight month of layoff declines, with numbers for both companies with layoffs and total employees laid off down 76% and 80% respectively from January. Both are down roughly 50% from March. Total layoffs for the month were led by Lyft and Hyland Software both laying off about 1,000 individuals each.

Why this matters: Continued slowing in layoffs is signaling that we may be near the bottom in terms of tech layoffs. However, with continued uncertainty in the banking industry, as well as indications from large tech players such as Meta that more layoffs are on the horizon, it is too soon to say if we are making our way out of the woods, or if there is more bad news to come here.

Brought to you via layoffs.fyi

Secondary Market Sentiment: the long winter

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.

It has now been 2 full years of negative secondary market sentiment. That being said the volume over the past 6 months is up 30% compared to the same 6 month period a year ago (Nov-Apr).

Why this matters: A return to liquidity in the private markets was never supposed to happen overnight. The recent banking crisis of has definitely put a hold on some of the positive momentum we have seen (especially since it has been centered around banks tied to venture and startups). Transactions are happening which is still a big step towards a private market recovery, but we will need the IPO/M&A spigots to start flowing before things return to “normal” (we put quotes around “normal” because the prior bull market was anything but normal).

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

Multiples have continued to recover after months of steep declines from the previous last twelve months. Since starting the newsletter, we actually have seen our first multiple recovery, with cryptocurrency multiples being up 31% from April 2022. Cryptocurrency in general showed some recovery during April (BTC is up more than 70% year to date), and the multiple increase is reflective of this rally. Enterprise SAAS saw the largest YoY multiple decline at 36%, followed by FinTech at 23% and Consumer and Real Estate at both 15% declines

Why this matters: Multiple declines are continuing to soften as we see some economic recovery. While cryptocurrency multiple upticks are impressive, the industry is so volatile that we don’t think you can put a ton of stock into one month’s worth of data. It will take a couple more months to determine if the uptick is actually meaningful or not. For the rest of the sectors we are covering, all eyes continue to be on the Fed and how they will respond to the current economic climate. While the market has priced in a 25 bps increase for May, any further increases are sure to shake up the market a bit.

April's Top Ten:

  1. IBM acquired SaaS-based PrestoDB provider Ahana for an undisclosed amount to further its strategy to invest in open source projects and foundations. Ahana has raised about $32 million in funding to date from investors such as Lux Capital, Third Point, and Liberty Global.

  2. The IPO market is showing a few signs of life with Klaviyo reportedly hiring bankers for a late 2023 IPO. Additionally, SeatGeek filed confidentially for IPO, adding to the list of companies that might hopefully restart the IPO market later this year.

  3. Delivery service Gopuff was fined $6.2 million by the state of Massachusetts for improperly classifying nearly 1,000 drivers as independent contractors rather than employees. A Gopuff spokesperson said the company strongly disagrees with the fines and intends to appeal them.

  4. Despite the regulatory uncertainty surrounding TikTok this past month, ByteDance, TikTok’s parent company, raked in a record profit in 2022. Profits increased from $14 billion the previous year to $25 billion this past year, and the company officially overtook China’s long-reigning the giants Tencent and Alibaba for the first time ever.

  5.  It appears that the banking crisis facilitated by SVB’s fall continues as it takes down another popular bank among start-ups and VC funds. JPM announced it will be acquiring First Republic Monday morning after Californian financial regulators took possession of the bank. It is the second largest US bank failure ever.

  6. The Information reported recently Discord revenue growth has slowed to 44% in 2022. While a slowdown from the 126% expansion in 2021, the company’s still solid numbers point to a promising navigation of the current economy.

  7.  VC funds that deployed at the height of the tech boom are continuing to have to take their medicine on marking down losses, and Tiger Global is no exception. It was recently reported that Tiger’s $12.7 billion venture fund, which was launched near the peak of the tech stock boom in October 2021, has told investors the fund had a paper loss of 20% net of management fees as of December.

  8.  The AI rush continues, with Bessemer continuing its investment in the space. Most recently, they won the deal to lead EvenUp’s Series B round at a $350 million valuation. This is more than 4x the $80 million valuation of the last round 18 months ago.

  9.  While Instacart has been struggling over the past couple of months with valuation cuts, the company has reportedly hiked its internal price by 18% in late February. The new price implies a corporate valuation of about $12 billion. This is still down notably from its peak internal value of $39 billion that was set in early 2021. Investors’ interest in Instacart has also peaked some this month, with bidders in April representing 88% of total interest in Instacart shares while sellers only accounted for 12%, according to Zanbato.

  10.  Fintech start-up Clear Street raised $270M in a second tranche of Series B round at a $2 billion valuation. The round was led by Prysm Capital, and brought the total round funding to $435 million. The company, which says it is building “modern infrastructure for capital markets, had only been operating with capital provided by its co-founders until last year.

Why this matters: First Republic’s failure marks another blow to the VC space, as it offered many products to assist both start-ups and venture capital funds (similar to SVB). The big question now is if J.P. Morgan is going to continue to provide similar products and options to support this clientele. In an already uncertain economic environment and after the nightmare that has been the recent bank collapses, players in the industry are going to be looking for stability.

Startups that are still hiring!

Open positions are per the company's website.