A well-selected portfolio of startups — one that includes at least 15-20 ventures that have all been subject to an appropriate level of due diligence, including making sure it's being run by a high-quality team and that they are going after a massively valuable market — will generate an internal rate of return of circa 25-35 per cent.
All the signs are we are coming to the end of one of the longest bull runs in history. In bull runs, startups and their investors benefit from easier access to capital and there are more liquidity options as bull markets are more conducive to acquisitions and IPOs which realise the returns of startup investment.
In bear markets, only the best startups survive. These are startups grounded in genuine value and tend not to be those validated purely on their momentum. "Momentum-based" investment tends to rely on growth for growth's sake, often needed to justify unrealistic valuations which have been hyped up to deliver outsized financial returns ungrounded in intrinsic value — think WeWork.
Valuations in bear markets tend to be lower. They are grounded more realistically in actual value. Lower more realistic valuations provide a more rewarding upside for investors and founders when the cycle swings back. Bear markets also tend to mean access to talent is cheaper.
I attended the recent USA Angel Capital Association conference where Ron Weissman from San Francisco's Band of Angels did some crystal ball gazing. He noted we are coming to the end of a 10-year party observing that share prices have fallen dramatically in recent months and public company mergers and acquisitions are already down by a third. He suggested the Initial Public Offering (IPO) window is nearly closed, with 50 special purpose acquisition companies currently underwater and Tiger Global, a voracious venture capital (VC) investor, having lost two-thirds of its nearly US$25 billion gain in recent months.
Weissman set out lessons from the recent recessions: Late-stage companies tend to suffer most in downturns. Angel backed startups, on the other hand, suffer the least impact. He did caveat this by noting this won't be the case if there is a series A crunch, but with US$300b in VC "dry powder" this risk is low.
Market declines are great times to build companies. We should not think short term. Startup companies need up to eight years to mature.
Early-stage investors and startups should have a clear line of sight to three or four times the follow-on capital for every early-stage dollar they invest.
AANZ, NZ Growth Capital Partners and PwC recently released data that provides a snapshot of New Zealand's 2021 early-stage venture market. Mirroring other capital markets around the world, it revealed our highest-ever uplift in investment in both deal and dollar terms — we recorded 172 deals (compared to 100-130 for the past five years) and $254m of investment (up 60 per cent on the previous year and twice the size of any other percentage uplift in investment since we started collecting data in 2006).
This scale of uplift year-on-year, even in a bull market, is not sustainable for a number of reasons including the rate at which Aotearoa can produce quality startups and the depth of our capital markets.
That said, it's taken us 15 years to invest $1b in NZ startups. The Angel Association and others in our ecosystem, such as Global Entrepreneurship Network NZ and the newly established Startup Advisory Council, have huge ambition to substantially lift the quality and quantity of startups.
The AANZ hopes we can maintain at least $250m of investment per annum in startups for the next 5 years to invest the next $1b in the next 5 years — not 15 years.
If we are to deliver the impact we know startups can have on New Zealand's future, we all have a role in making sure this happens.
• Suse Reynolds is the executive chair at Angel Association New Zealand.
