Roundtable #4 with Jason Lemkin, Woody Marshall, Deven Parekh, Harry Stebbings | E1071

Market Sentiment and Activity

• The market is characterized by a "glass half full" perspective regarding recent activity:
  • The tech sector experienced over a year without a tech IPO or meaningfully large strategic M&A.
  • Cisco recently acquired Splunk.
  • Three companies recently completed public offerings at real scale with verified business models.
• Underlying company growth remains robust despite macro headwinds:
  • In Q2 2023, Insight's 180 portfolio companies grew by over 50% year-over-year.
  • However, the pace of new investment deals has dropped dramatically compared to 2021 and 2022.
  • Series A and B investments from 2021–2022 are now facing capital needs as those funding rounds only covered 12–24 months of runway.

Valuation and Capital Dynamics

• Significant valuation disconnection exists between buyers and sellers, creating a "deal drought" for companies refusing to reset expectations:
  • Companies previously raised at valuations of 100x ARR, necessitating significant equity and option realignment to motivate teams.
  • Many firms hold $300M–$500M in cash reserves from 2021, removing the immediate urgency to raise capital at current depressed prices.
  • Investors are actively seeking to purchase assets at a discount (e.g., "buying a dollar for 75 cents").
• The market is shifting toward profitability and efficiency:
  • Public market correlations to revenue growth have dropped from ~72% in 2020 to the mid-30s, with free cash flow and path to profitability now being primary valuation drivers.
  • The "Rule of 40" composition has shifted from requiring 60–70% growth with negative EBITDA to 30% growth with 10–20% EBITDA.
  • Late-stage growth (pre-IPO) funding is currently the least active segment, with Databricks noted as a notable exception.

Investment Strategies and Terms

• Structured terms (e.g., preferred stock with guaranteed returns) are viewed as potentially misaligning incentives between founders and investors:
  • Such terms can discourage beneficial early exits if the guaranteed return threshold is not met.
  • Investors prefer being on the same side of the table to drive enterprise value rather than creating opposing motivations based on security type.
• Secondary transactions are increasing as a source of partial liquidity for early investors who have not yet seen full exits.
• TCV invests in growth assets where ~70% are at $50M+ revenue, with about 50% being profitable (though profitability is not a strict requirement).
• Insight manages approximately $70 billion in SaaS assets across early growth to buyout stages.

IPO Outlook and Future Expectations

• A consensus exists that the IPO window will reopen in the second half of 2024:
  • Jason Lemkin and Devin Parekh anticipate the market opening "back half of next year."
  • The closure of the late-stage private market does not necessarily delay IPOs, as companies can utilize the public market directly for valuation and liquidity.
  • Recent IPOs (e.g., Instacart, Klaviyo) involved small sell-downs (under 10%), allowing public markets to determine long-term valuation based on execution rather than private pricing.
• The market is expected to settle at a normalized pace, contrasting with the "frothy" 2021 environment:
  • Longer due diligence periods (months vs. weeks) will return, allowing investors to build deeper relationships with management teams.
  • Long-term software multiples are currently below the 15-year median but not by the 40% contraction seen during the 2022 trough.

Artificial Intelligence (AI) Sector

• Investors are approaching AI with caution due to a current hype cycle where valuations may be exceeding company fundamentals:
  • Insight allocated ~7–8% of Fund 12 to AI, but almost zero was invested in AI specifically during 2023.
  • Most investments in AI infrastructure were made in 2021, where pricing may have been more favorable than current LLM-focused rounds.
  • TCV has not made direct AI-specific investments, though 100% of their portfolio companies are leveraging AI for efficiency and product features.
• Long-term AI adoption is viewed as a fundamental trend with significant impact, despite current valuation risks.

Specific Investment Bets and Examples

• A specific case study involved a SaaS company with 50% growth, 100% Net Retention Rate (NRR), and zero burn; investors suggested it is fundable and worth at least a 1x revenue multiple, potentially higher depending on long-term compounding.
• Betting scenario established regarding Klaviyo:
  • A bet was placed that Klaviyo's stock price will be $20 or higher (a ~40% increase from current levels) within 12 months.
  • Devin Parekh declined the bet personally due to spousal restrictions, though he supports the $20 upside assumption.
• ARM stock was identified as having potential volatility driven by chip shortages and AI demand, though the speaker admitted a lack of specific fundamental knowledge to bet on it.