The Bull Case for Venture Capital in a coming Bear market

Don’t fear the bear. History suggests that we may be entering a superb time for tech investing.

 A Black Swan Health Crisis; Not a Tech-lash

As sad and horrific as the human toll of COVID-19 is, from a market perspective what we are experiencing is not akin to the wholesale collapse of tech valuations following the dot-com bust of 2000–01. COVID-19 was (and is) a black swan health crisis, not a tech-specific market selloff.

While some recent tech IPOs have not fared well, the reasons for the public market’s lukewarm response to those debuts have more to do with the underlying fundamentals of those businesses. It should be noted that the market has not soured on tech companies per se; it has soured on wildly unprofitable tech companies with wobbly unit economics, unsound management practices, and still-unproven business models.

While a bear market will encourage investors to be even more skeptical of such businesses — and, in some cases, to conduct actual due diligence, not simply the illusion of due diligence — it will not unduly prejudice the technology sector.

Bear Markets present exceptional opportunities to build sustainable businesses

While it’s true that great companies are founded in all markets, as is often repeated, some of the biggest technology names were formed during challenging economic times: AirBnB (‘08), Yammer (’09), Square (‘09), Stripe (‘09), Facebook (‘04), Uber (‘09), Groupon (‘08), Playdom (‘08), Adobe (‘82), and Microsoft (‘75), to name just a few.

Arguably, a bull market may be the most challenging time to launch a startup. Witness what we’ve experienced in Silicon Valley and in a handful of other established tech hubs in recent years: a ferocious competition for talent; unprecedented hiring challenges and wage levels; costs for office space and service providers at all-time highs; tight housing markets; skyrocketing rents and living expenses for employees; community backlash; and so forth.

While a bull market might more easily enable a budding entrepreneur to secure funding for her lofty startup vision, it often enables many other budding entrepreneurs to secure funding for directly competitive ideas.

Those startups are then forced to exhaust a good amount of their investors’ capital competing against each other and not focusing on the incumbents. In the end, the infamous Peter Thiel quote proves accurate: an enormous amount of the venture capital that startups raise in a bull market ends up in the pockets of landlords, service providers and of companies like Google and Facebook, not taking on incumbents and building sustainable businesses.

Bear Markets ‘lower the volume’ so teams can focus

Great companies and robust products take time. In frothy markets, startups feel undue pressure to continue raising capital and guarding their flanks against competitive startups launching in their wake, seemingly every week. In a bear market, there’s a flight to quality and, as a consequence, fewer competitors are securing funding. As such, those teams that do raise capital can actually focus on building a great company, a robust product and a sustainable market position. And, unlike in bull markets, startup CEOs are not unduly preoccupied with team attrition; their best engineers are not constantly being poached by better funded, more established rivals. Team cohesion improves as a result.

Bear Markets typically generate better venture returns

Correspondingly, bear markets are exceptionally good markets in which venture capitalists and limited partners should be actively investing. Much as startups can take advantage of a less hectic pace to build consequential companies, venture capitalists can also spend more time with their portfolio companies to coax those companies into their fullest expression. VCs still must work as hard as ever, but the focus seems more channeled and directed, less scattered, and less driven by FOMO.

Moreover, the trickle down benefits of a bear market to a venture investor — lower OPEX costs for one’s portfolio companies, more available talent, more rational valuations, a smaller competitive set, etc — has the effect of making a GP’s capital go a great deal farther than it does in a frothy bull market. And those lower valuations and longer runways for portfolio companies for the same invested capital has a direct and positive impact on venture returns.

For LPs, similar dynamics are at play. Historically, the best VC fund vintages tend to have been those that were invested during bearish markets. For LPs to step away from venture now when valuations will almost assuredly come down, capital will go farther, and ownership stakes for that same capital will increase, would be a mistake.

LPs that were spooked after the dot-com bust and sat out the 2002-06 period missed the Consumer Internet/Web 2.0 wave and some of the best VC returns in a generation. Similarly, those that retreated following the GFC of 2007–08 missed enormous returns generated in the venture asset class from investments made in startups between 2009 to 2015.

Tech Innovation does not stand still

The global technology innovation boom shows no sign of abating; if anything, it is accelerating. Technology progresses irrespective of where the Dow sits that week. Moreover, in turbulent times there is an even greater focus by both enterprises and consumers on controlling costs, which naturally favors startups deploying technology solutions to drive efficiencies.

At Catapult, which has a specific focus on investing in emerging tech ecosystems outside Silicon Valley, we spend a great deal of time in nascent tech hubs across North America, the EU and Central/Eastern Europe. In our extensive travels, we have found that it is in some of the most under-served markets like Istanbul or Tbilisi where the entrepreneurial spirit is most in evidence; and those markets have virtually no venture capital ecosystem to speak of; just incredibly resourceful entrepreneurs with an indomitable spirit to compete and win.

And whether a startup team is in Kansas City or Kuala Lumpur, it is most likely using Slack, or Zoom, or Trello, or any number of workforce collaboration platforms that can enable it to be both globally competitive and cost competitive as it sources the world’s best talent, regardless of where it resides.

Today’s worries over COVID-19, unnerving as they are, will only accelerate interest in companies and investors squarely aimed at fueling the current remote workforce collaboration revolution. This is a core investment theme at Catapult and an area in which the partners have been long-time investors. As the COVID-19 crisis abates, whether in weeks or months, there is no reasonable likelihood that interest in remote workforce collaboration will suddenly go fallow. This is not just a trend; it is a fundamental shift in how enterprises and workplaces will look and function going forward. There is no going back from this.

Silicon Valley, which has enjoyed a 70-year reign as the world’s dominant tech hub, will likely experience a contraction in job growth and economic expansion during the coming cycle. However, we believe this contraction will ultimately accrue to the benefit of the Pittsburghs, Berlins, Lisbons, and Barcelonas of the world where technical talent has quietly been coalescing, where valuations and costs have remained reasonable, and where low cost of living and quality of life has long been a draw for the well-educated, newly affluent and tech-savvy.

In Summary: Tech and VC is increasingly a global driver of economic growth.

Finally, while a bear market may temper the rate of the current global innovation boom it will by no means extinguish it because the catalyst behind this period of innovation has little to do with capital and much more to do with the irrepressible entrepreneurial spirit and with the desire of founders to apply technology solutions to address fundamental global challenges.

It also has to do with increasingly compliant governments around the world that see the promise of technology innovation to re-tool their economies from those long driven by old world industries like mining and manufacturing to ones that prioritize high value intellectual work and entrepreneurship. This, in turn, stimulates job creation, quells the brain drain, expands the tax base, and creates the flywheel effect of a robust tech hub, which attracts future generations of visionary founders to those geographies.

With the recent advancements in workforce collaboration technologies and the availability of low cost bandwidth and cloud storage, addressing these challenges becomes a question principally of ingenuity, not capital. And there will always be sufficient capital for mission-driven founders with bold ideas that are addressing fundamental problems and have the potential to achieve global scale. For us at Catapult, we’re excited by the enormous opportunities in the years ahead for tech innovation and tech investment and we’re decidedly open for business. You should be as well.