This year has been chastening for technology investors and portfolio companies alike. Analysts have been discounting their future earnings expectations, causing steep declines in the public stocks that private equity managers value their assets against. Many company founders and employees have seen their paper wealth diminish rapidly.
Jeff Lieberman, managing director of Insight Partners, has experienced a few downcycles in his near-25-year career with the growth and venture capital investor, which in February closed its 12th flagship fund on $17.23 billion. Among the companies he has backed over the years are Qualtrics, DeliveryHero, HelloFresh, Cvent, Mimecast and Udemy.
Lieberman spoke with affiliate publication Private Equity International about tech investing in a downturn and how the age of rapid growth funded by cheap capital is over.
Growth at any cost is out
In an environment of higher interest rates, companies that demonstrate steady growth and profitability are better bets for a group such as Insight, as opposed to those that grow rapidly but unprofitably.
“In a theoretical example, if you had free money, you would do lots of stuff that you wouldn’t do otherwise,” said Lieberman. “Your objective function was growing as fast as you could. Now your objective function is to grow efficiently, which means balancing the top line with the bottom line.”
Can you get funding? If not, think twice
A rise in the cost of capital has put tech businesses at a crossroads. The most resilient companies should strive to become “fully funded forever,” where raising capital is an option and not a response to a shortfall. Failing that, companies should try to ensure that unit economics are as attractive as possible to potential investors. “If [neither of these are possible], then I think you have to look honestly at the business and say: ‘If we’re not there today, can we get there?’”
Hard lessons go down easier than in previous cycles
It can be painful or even traumatic for founders and employees when the value of their business is slashed by the market. It is also difficult for GPs to explain that the way they think about the business needs to change in line with evolving market conditions. In Lieberman’s view, the message is sinking in more quickly during this downturn due to the proliferation of information via podcasts and social media.
“Now, typically we’ll have that [difficult] conversation and they’re like, ‘Well, I already heard that.'”
What are businesses likely to cut back on?
Corporate budgets are being trimmed. The job for tech managers is to guess what will avoid the chop and invest accordingly, Lieberman said. Sectors likely to remain a priority are things like cybersecurity, with cybercrime posing a major, ever-evolving threat to businesses. Anything that reaps immediate rewards will also be prioritized.
“If you have a very long payback period, that [investment] is something that’s probably going to be deferred for a couple of quarters,” Lieberman said.
IR lessons for emerging managers
Last summer, Insight finished deploying its first Vision Capital fund – a $15 million vehicle raised by Insight’s senior partners that invests in emerging VC firms managed by people from underrepresented groups. By the firm’s reckoning, GP leadership in the portfolio is 83 percent Black or Hispanic versus less than 1 percent for the VC industry at large. In addition to offering these leaders a network and advice on how to allocate capital, lessons on investor relations are paramount.
“How do you communicate with people like us? How do you manage your professional investors in times like this? Our advice is to overcommunicate both the good and the bad. Surprises are bad; transparency is good,” Lieberman said.
Now is the time for LPs to invest
LPs reeling from write-downs might recoil next time a technology manager comes around asking for a big check. It is worth remembering that lower valuations mean more palatable entry prices for the best businesses. And this in a relatively immature sector that, particularly when it comes to software investments, offers investors inflation protection via fixed multi-year contracts.
Despite the decline in the stock market, “the performance of companies is actually quite strong across the board, which I think speaks to the notion that secularly, there’s still long-term trends and tailwinds for the adoption of soft technology, software and similar technologies.”
Lieberman added, “We’re way too immature and… not penetrated enough as an industry to have to worry about the cyclicality of what other people look at in other parts of the economy.”