The Current Market Turmoil

Navigating the current market turmoil is no doubt a challenge. Negative sentiment has taken over, but there are reasons to be optimistic. Transparency is critical in these times.

So, we are doing something different this time and publishing the letter we sent out to the Mangrove shareholders on May 17th. I wanted to share it with my readers and contribute to your thought process. You might agree or not; either way, I hope it helps frame your thoughts…

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Mangrove Shareholders Update

May 17, 2022

Dear Mangrove Limited Partner,

We hope this note finds you well.

After two long Covid years, uncertainty continues to define the world, albeit now for different reasons. Rampant inflation, the Ukraine conflict, and supply chain constraints combined with disappointing post-Covid earnings from public tech companies has resulted in a perfect storm that is beginning to have significant consequences on the venture capital industry.

Uncertainty is driving volatility and the stakeholders in the technology sector are worried. Consider a Twitter poll we ran in early May of this year which suggested that 47% of people believe that there is more uncertainty today than there was in May of 2020 during the heart of the Covid pandemic. While perhaps hard to believe given the magnitude of the Covid pandemic, one thing is sure: negative sentiment is driving the market.

In the short term, we are planning for a challenging year and working diligently with our companies. In the long term, we have taken the view that the outlook for our funds remains unchanged.

Short term: 2022

The most direct consequences of this perfect storm are twofold: 1) shrinking funding market and 2) pressure on valuation. As early as January 2022, we began noticing the telltale signs of an imminent change in the market. This has continued and worsened through the year, in line with the attrition of technology public stocks, a natural proxy for private technology companies.

We have rushed to close funding rounds, bolster balance sheets, and encouraged all of our companies to do 'more with less' by reducing their expenditures. As a result, our portfolio is in excellent shape, and our companies are well-positioned to face 2022. Of course, there will be exceptions, with natural portfolio attrition as well as potential downward valuation adjustments for some of those needing to raise capital.

More specifically, let us share five thoughts:

1. Funding

The funding market is rapidly shrinking as investors respond to market uncertainties by reducing their investment pace. We are seeing term sheets being pulled, due diligence taking more time and less competition for good deals. This is broad, across all industries and all geographies. Having just returned from Israel, we can confirm the pattern is very similar to Europe.

2. Valuation

As a result of a shrinking funding market, we are seeing pressure on valuations. For some of our companies, it simply means the next funding price will not be as high as it might have been 12 months ago, while for others, it will require pricing the company below the last round valuation. We are not particularly worried by this as it bears little relevance to intrinsic company quality, but rather reflects the operative word of 2022: bargain. After a long entrepreneur-friendly pricing market run, the pendulum has swung back in favor of investors, and they are bargain hunting. For our latest fund, Mangrove VI, this is an opportunity and we fully expect to come across exceptional opportunities.

3. The public market 'comp' problem

Driving much of the negativity around public tech stocks is the perceived slow-down of growth. After two exceptionally Covid boosted years, companies have been reporting lower quarter on quarter growth in 2022 when compared to 2021. This phenomenon holds true across all tech stocks and has contributed to driving the NASDAQ down 30% since Jan 1.

That we are living a post-Covid slow-down is obvious, but we do not believe it is a trend. Rather, we consider 2022 a transition year back to pre-Covid times. During 2022, companies will be making adjustments and re-casting the foundations to execute during normalcy. The unprecedented nature of Covid requires us to look beyond simple 'comps' such as quarter-on-quarter growth because they are misleading and do not tell the whole story. In the meantime, they are driving volatility.

4. Private tech companies continue to execute

Curiously, we are not seeing the same thing in private companies. For most of the good companies in our portfolio, Q1 2022 quarter-on-quarter growth has been excellent and reflects the health of our portfolio. Consider RedPoints, Adverity, TailorBrands, Flo and KHealth as examples. This is very different from previous market downturns and suggests to us a very different outcome. Of course, inflation and the Ukraine conflict will weigh on the global economy, but our portfolio is well positioned to continue to grow.

5. Continued investment

We will continue to invest in 2022, albeit at a slower pace than in 2021. As is our habit, price and ownership will continue to be focal points. This low volume high conviction approach has always been the foundation for strong and long-term partnerships with our entrepreneurs. As with previous downturns, the market favors bold and decisive investors who can partner with great entrepreneurs, and we are already seeing signs of early-stage price readjustments, so it is important to remain very active and close to the action. No doubt, the conversations we are having with entrepreneurs are difficult, and the change in the market is brutal, but the smart ones get it. We are confident that we will find excellence in the turmoil.

Long term: 2023 and beyond

Our optimism remains intact. A bet against the Internet and innovation is never a good idea, and some of our most important successes were investments made during previous market downturns. The underlying investments of our funds are strong, and they are well-positioned in their respective markets and most well-capitalized to continue to excel.

We hope this note provides you with some insight into how we are confronting the challenges of the current market turmoil. While challenging for all, we look forward with optimism.

All the best to you and your families,

The Mangrove Team.

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The good news is this is actually a great time to build a company. Many of the most iconic companies were founded, and some of our best investments were made, in these tough markets. Think Google, Skype, Amazon, Wix, Salesforce, Airbnb, etc. Everything gets easier (recruitment, client acquisition costs, etc.), except raising capital... So, let’s focus on fundamentals and building great businesses.

I am in Paris and Vilnius this week. This will also be my first time in the Baltics this year. Hit me up if you are around.

Life is awesome,

Yannick

Other content I've found useful

- The 'dirty term sheet' by Bill: Due to jarring changes in the startup capital markets, many founders that run short of cash will try to irrationally maintain their past market capitalization. Despite public comps down 50%+, they will still insist on trying. Enter the "dirty term sheet." Which is a huge mistake.

European VC Europe