Like many financial services hedge-fund crossover investing makes money by charging fees for assets under management. They bring in more investors by showing gains in the market. In late stage startup investing, this creates the incentive to inflate valuations. By deploying larger amounts of money faster than traditional venture capital, hedge-fund crossover investors can win deals and push the valuation higher in subsequent rounds showing higher and higher paper gains.
As long as there is never a write-downs—which neither investors nor CEOs would want to do—it’s a great way of monetizing inflated startup valuations.
Unfortunately, this seems to be one of those investment strategies that only works in a bull market. Tiger Global lost $25 billion (and counting) as of June 2022 ($5 billion of that in their VC fund) making it the biggest loss in hedge fund history.
Read Late Stage Prisoners Dilema by Ranjan Roy.
See also:
- Write-downs are coming as inflation causes downward pressure on startup valuations
Links to this note
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Running a Startup During a Recession
Startups are a microcosm of the economy and we can observe that things are changing quickly towards a recession footing. The effects of inflation on valuations are readily apparent, but we also see that things were too good to be true and investors and late stage companies exploited it.
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Revenue Multiples Fell from 24x in 2021 to 10x in 2022
Enterprise Value (EV) to Next Twelve Month (NTM) revenue multiples in public markets for SaaS businesses rose sharply from 2019 to 2021 up to as high as 24x. Now, those multiples are falling below pre-pandemic levels to 10x. This has major implications for retail investors, VCs, and running a startup during a recession.
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Private Investing Avoids Visible Volatility of Public Markets
Private investment firms like venture capital and private equity are in the business of avoiding visible volatility of public markets. Because private assets don’t trade and investment managers go to great lengths to keep them from going down, assets appear to mostly appreciate (there are down rounds and losses, sometimes the chicken comes home to roost, but for the most part this is true) even when public markets are tanking.