Investor and entrepreneur Anshu Sharma, formerly Storm Ventures, now CEO of SkyFlow focused on privacy asked on Twitter today on the connection between interest rates and technology valuations:
Ignore the compliments; Sharma was just trying to prime Jeff and I to participate with your question. That worked as you can see.
Sharma is someone with a lot of experience with both technology cycles and capital flows, so he is not asking the generic question: he wants us to dive into the concept. So, let’s take a look at the interest rate / tech valuation conversation.
One of the reasons startups can raise as much money as they do (record sums, remember) is the current low interest rate environment.
Interest rates are low around the world, which means money cheap. Cheap money means you can raise capital for little money. Coinbase, for example, is raising $ 2 billion in debt at the moment it will expire in two tranches. The first, due in 2028, will yield 3.375%, while the second semester, due in 2031, will yield 3.625%. Coinbase raised its target from $ 1.5 billion to $ 2.0 billion thanks to investor interest. Money is cheap, which is why Coinbase is piling a bunch on its side of the table of investors who can’t find lower-risk, higher-return places to store their capital.
Cheap money means you can’t wait long to lend your funds; Bond yields are junk today for that reason, which is great for companies like Coinbase and less so for equity groups looking for returns. Those same buckets of cash have gone fishing elsewhere in hopes of getting more profit per dollar, including the venture capital market. The ample capital has allowed venture capitalists to raise bigger and bigger funds, faster, and has allowed non-traditional investors to flock to the startup market.
A good part of the unicorn boom is based on this time of cheap money that we find ourselves in.
But nothing lasts forever, and with the US government. ready to start turning off the taps on buying market stimulating bondsand, finally, increasing the internal cost of money by increasing the target range for the Federal funds rate, there is an expectation that certain assets will begin to lose some of their luster.
If money becomes more expensive, capital can make more money by hiring itself for others; Hence, risk investing will become less attractive from a risk / reward perspective, again, in theory. At the same time, the stock market can change its price. Soaring interest rates have prompted investors to buy stocks in growth-oriented companies because those companies were expected to be priced higher than similar investments in slower-growing companies.
This particular trend reached its zenith last summer, when several industries were frustrated by early COVID restrictions and software stocks offered a way to continue to seek performance through the prism of companies. revenue growth, payable not in a regular coupon disbursement, but through the accumulation of market value.
In very general terms, increasing rates should Making equity investment in venture capital funds less attractive simply by making competing asset allocations more attractive. And rising rates may make trading in value through growth in public stocks less attractive as other stocks take center stage again.
There are technical explanations for the last part of our argument. Here are a few from Sharma’s Twitter thread:
But Sharma is not really behind that set of responses. Instead, you are questioning conventional wisdom. Why should it be true?, he is asking, Tech stocks like Amazon and Salesforce will be worth less when rates go up, are they really worth less? In Sharma’s worldview, the growing market for fully addressable e-commerce and software has made those two companies worth more than previously anticipated; Why should those gains disappear if money gets more expensive?
We have to move not in absolute terms, but in basis points, to get the argument here. Interest rates, when they change, will change slowly. It seems unlikely that many governments will quickly turn the money price crank. Changes will occur gradually and with caution.
So apart from feeling Changes that could lead to related changes in asset prices, or end up being more extreme than structural developments, we really shouldn’t expect many changes in the key dynamics of the current market when rates start lift up. Or, more simply, a 25 basis point change in the Fed’s target rate (0.25%) will not mean much on its own unless further increases are expected on a regular and rapid basis.
The value of Amazon and Salesforce probably It shouldn’t change much when the price of money starts to slide higher. If rates manage to hit 5%, then sure, Amazon’s market capitalization will likely decline relative to the value of other assets, but that’s more of a comparative shift than a demand that Salesforce et al lose value.
Sharma discusses the base case with a wink. It is a software bull. But your question raises a good point for us to analyze: When the underlying factors responsible for part of the boom in software value and the wave of software investment change, how quickly will valuations change? (Put another way, when what is driving the relative price appreciation of growth-oriented income changes compared to other assets and dollars flowing to SaaS, how quickly will the results of those factors change?)
Those who anticipate a drastic price shift in tech valuations from initial incremental changes in the price of money, I think, expect a bit more of an exclamation point than they will actually read.
That’s why The Exchange wrote the following the other week, when it discussed the current startup boom and its potential durability:
But what we do think is possible to say with some certainty, or at least more so than when a rebalancing of capital can occur in the larger economy, is that it will take a somewhat large bypass to bring the startup game down from its current base. . Product demand coupled with financing interest is a perfect combination to drive investment decisions: Capital pursues performance and high-growth companies seek capital. It’s a match made in heaven.
Additionally, many investors we’ve spoken to during this reporting cycle have been optimistic about the quality of the founders and the startups in which they have the option to invest. There is not only market demand and capital, but what is being built to respond to the former with help. The second is pretty good, at least from the point of view of the people who write seven-, eight-, and nine-figure checks to the startups in question.
Cycle of all business cycles. All things that go up eventually lose some altitude. But the appetite for start-up stocks and tech stocks in general will not return to Earth in 1g. Instead, a decrease in lunar gravity seems more likely. Pending something new, of course.