The startup investment landscape is grappling with a significant liquidity shortage, prompting investors to pivot towards mergers and acquisitions (M&A) as a solution to infuse capital into the ecosystem.
Such is the standpoint of Ryan Hinkle, managing director at Insight Partners, a prominent New York-based venture capital firm. Insight Partners gained considerable attention for its robust investment activities during the private tech company surge of 2021 and into the first half of 2022, culminating in the unveiling of its largest fund to date at $20 billion.
At the heart of the liquidity issue is the scarcity of exit opportunities for startups, leaving venture funds’ limited partners with vast holdings of immovable assets. “Those who manage capital for others have endured years of reduced liquidity, which has a domino effect across all markets since that capital is intended for future commitments to new funds,” Hinkle explained.
He believes that the venture ecosystem cannot revert to its typical state, with startups securing funding, until IPOs and M&A transactions release these trapped funds. Hinkle notes, “There’s a cycle where today’s commitment turns into a return and then a new commitment in three to five years. That cycle has either stalled or slowed considerably.”
Although exits are crucial for liberating the system, IPOs are still infrequent. Hinkle underscores the fact that IPOs do not provide liquidity in the same immediate manner as a merger or acquisition does.
During a discussion with Crunchbase News, Hinkle shared his expectations for a surge in activity from private companies acquiring other private entities in the current year, even more than public companies purchasing startups. This movement could potentially unlock capital for limited partners.
Despite the frenetic investment pace of 2021, Insight Partners has moderated its investment activities. Yet, its investments from that period position it as the fifth-most active investor on The Crunchbase Unicorn Board, indicative of a considerable portfolio of illiquid assets. Insight Partners, established 28 years ago, managed $80 billion at the close of 2023, with a strong focus on investing in software.
Some of the firm’s most significant exits include X (formerly known as Twitter), Delivery Hero, and Monday.com, all of which date back several years.
Market Dislocation
The vacuum of venture-backed startup exits has led to a less vibrant funding climate, resulting in layoffs and the shuttering of businesses due to the evaporation of follow-on funding. While IPOs attract attention and interest, they do not essentially address the liquidity challenge, according to Hinkle.
“IPOs are not liquidity events; they’re financing events,” he clarifies. Post-downturn, many investors abstain from liquidating their stakes during the IPO, and exiting a large position in a public stock can be complicated.
Hinkle points out that while an IPO may be the value-optimizing path, it is merely the commencement of a journey towards liquidity. “The quickest route to actual cash liquidity is selling a company,” he asserts.
A recent Kauffman Fellows report aligns with this sentiment, revealing that investors are eyeing M&A and secondary market sales to regain liquidity this year.
Uncertainty in the IPO Markets
Prospective public companies are generally advised to forecast eight quarters of predictable revenue. “Predictability is challenging at present,” Hinkle observes, noting that a single adverse geopolitical event or inflation data point can inject uncertainty.
With many companies facing IPO valuations below their last funding round, reconciling reduced valuations is tough for investors who previously invested at higher values. It takes a unique company to go public, with various stakeholders involved in the IPO process focusing on different aspects such as value, preparedness, potential gains and risks, and long-term versus short-term objectives.
Beyond the Reset
Though the capital markets don’t offer immediate liquidity solutions, the public markets have enforced a frugality on companies. Hinkle believes that this period of austerity will have a lasting positive impact, as companies emerging from it will adopt a mindset of efficiency that will perpetually be in vogue and lead to better long-term outcomes.
