In a word, it is quite strong but likely heading to turbulent times. Over the last few decades in the US, the robust system of financing startups and high-growth young companies has been the source of many well-paying jobs and a generator of wealth for investors and employees. Health care gets more than its share of this activity, since it represents so much of the economy and of growth opportunities. The last couple of years have seen both very strong merger and acquisition markets and initial public offering markets, which have created incredible liquidity and returns for investors, who in turn have plowed immense amounts of capital back into new and emerging companies. This activity has often been irrational, and in the last few weeks we have begun to see the inevitable outcome of this irrationality, as stock prices of ethereal, newly-public companies fall precipitously and M & A activity begins to slow. The National Venture Capital Association issues regular reports that track fund-raising by venture capital and private equity firms, investments by those firms and exits. Here is the latest report, detailing the record pace of investments and exits. Enjoy the good times, they never last. (NVCA Report)
M&A and venture capital have been coasting on super-low interest rates for some time now. A super-low bond yield sets the bar fairly low for venture capital. I can remember when the 10 year Treasury rate was 3.5% (Jan 2011). Yes, a while ago but at the same time inflation was running at 3.2%. Now I know this is simplistic, but the 10 Year Treasury/CPI gap was only a positive 0.3% (30 basis points).
Roll forward to January 2015, the CPI was 1.6%; the 10 year Treasury 1.9% – still a positive 30 basis points. Then we go to today – CPI (December 2021) was a whopping 7.0%; 10 year Treasury is 1.8% – a gap of a negative 520 basis points.
Why is this important to venture capital? Well, if you buy into Biden and the Fed’s assertion that inflation is just “transitory” then we would expect the gap to go back to +- 30 basis points and the CPI would fall to about 2%. But if they are wrong, and the gap goes back to a recent historical gap, we are in for 10 year Treasury rates at about 7%-7.5%. If you are a venture capitalist you are going to want a much better yield than a risk-free Treasury rate – say at 10%-15%. So what would a venture capitalist do? Maybe, just maybe, withdraw from the market until inflation recedes.
the real problem is doing what they have done in the past–make investments in phantom companies at huge valuations–no possibility of a return as you run out of greater fools eventually