VCs will paly a vital role in shaping our future

Number of VC backed tech companies making their debut in the public market is increasing both in terms of a number of deals as well as the amount of money raised. As the data shows in the tables below, venture-backed companies took over half the IPO market, the highest since 2012, the year when Facebook made its debut. In my opinion, this trend is likely to stay at worst and we may see this move higher, making venture-backed IPOs a majority source of the IPO market.

This trend can be attributed to three factors: the current zero interest rate climate, successes stories of the alternative channel to access the public market and the rise of millennials and Gen-Zs in the public stock market.

Zero-interest rate climate

The Federal Reserve has, over multiple meetings, told the market that the interest rate will stay at the current near-zero per cent rate for a foreseeable future (or at least until 2023 according to the latest meeting in September 2020). This gives an incredible boost not only to the stock market in general but also, and especially, to the venture-backed companies. The venture-backed companies typically operate in a unique business model where zero cash flow is distributed to shareholders and instead are reinvested for growth. They do so with a goal of creating a giant terminal value sometime in the future. This essentially makes the business model similar to a zero-coupon bond where a terminal value that is far out in the time horizon has an immense contribution to today’s valuation, making the company’s value sensitive to interest rate movements. From the investors perspective, such a business model has been deemed dangerous and hence they have been demanding a higher risk premium which put a cap on the company’s stock price. However, the low-interest-rate environment made forgoing current cash flow cheaper and more affordable, allowing the investors to reduce the risk premium. This essentially removed the cap, giving venture-backed tech stocks to surge higher.

Alternative means to public market access

There used to be a period of time when successful tech giants, or unicorns, shunned away from the public market due to 1) high cost of IPOs, 2) high cost in complying with public market regulation and 3) founders wanting to keep control. However, an increasing number of successes stories of tech companies in the public market (such as Amazon, Facebook, Tesla, Snowflake …etc) is luring the unicorns to reconsider the cost-benefit of floating their companies. To mitigate some of the costs, many hopeful unicorns are exploring an alternate means of floating their companies through vehicles such as SPAC and direct listing. This is reflected in the number of listings and money raised through SPAC which increase sharply in the last 2~3 years (see graph below).

It is essentially giving the entire VC industry a powerful exit option. This, coupled with my next point, is allowing VCs to take more risks with their capital.

(* Bill Gurley wrote a great article on this topic. You should read about it here.)

Millennials and Gen-Zs are rising

With the millennials entering the peak of their income power, wealth transfer happening from boomers to millennials and with Gen-Zs joining the working-age, favourite sector in the stock market is changing fast. The so-called household names in the stock market (such as JNJ, Philip Morris, Exxon…etc), largely shined during the rise of value investors, backed by the boomer generation, are no longer appealing to this new generation of an economic powerhouse. Instead, companies that offer product/services to connect them with their peers, free them from running ‘errands’, and poke their intellectual creativity are gaining interest. Most of such companies (such as Facebook, Google, Tesla..etc) operate online and through a software technology and hence Technology sector is by far the single largest industry sector backed by the new generation (see infographic below).

Apart from the appealing products/services of the Tech companies, the millennial and Gen-Z generation is also attracted to the sector because their time horizon is longer than the boomer generation. Unlike some of the boomer generation who is relying on an income generated by their dividend stock portfolio, the younger generation can make a more aggressive bet in exchange for an immediate cash need. Hence, they tend to be more receptive to a company whose goal is to send humans to Mars VS a company that has been selling a candy bar for decades.

These changes are nudging the unicorns and VCs to re-evaluate the cost-benefit of floating their company in the public market because now they have a growing fan base that will support the company’s vision, without penalising the companies for reinvesting their profits, and cheaper/faster way to access their capital.

Overall, the risk-taking and longer-term horizon should translate to a boosted confidence of the VC investors, allowing them to raise and invest more capital in the younger companies. This in turn will give the startup industry to take more chances with companies/founders that are trying to expand the boundary of our society. Realising that we live in this exciting era of this positive cycle being formed encourages me to continually improve myself and participate in the movement in a productive way.

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