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January 30, 2023 | Tom Ballard

Investor Outlook 4 | Thoughts on valuations

They declined in 2022 from very high numbers. What will happen in 2023?

The annual “Investor Outlook” resumes with more insights from our seven investors.

Today’s Question: Valuations have clearly declined from what many might characterize as unsustainable highs. Will this downward trend continue in 2023 or do you think it has about bottomed out? As far as founders, have they become more realistic about their values as 2022 progressed?

Scott Ewing, Principal Business Analyst, Appalachian Investors Alliance: If valuations are set based on popular narratives, valuations will trend according to what’s current. We’re tasked by our investors to help counter biases and to act rationally. Ours is a fairly fundamental method that usually begins by looking hard at the assumptions that underpin a proforma. That tends to deliver realism to valuation discussions.

Tony Lettich, Managing Director, The Angel Roundtable: Company valuation expectations have moderated. In general, we expect valuations during 2023 to remain flat or to decline slightly. However, this expectation is based upon the assumption that we don’t see high levels of volatility, and that the potential risk of headwinds that could significantly impact the macro economy are moderated as 2023 progresses.

Grady Vanderhoofven, President and Chief Executive Officer, Three Roots Capital: From my observations, many founders have not yet been recalibrated regarding valuations at the beginning of 2023 relative to the end of 2021. From inside a company, it’s hard to understand and rationalize how a company can be generating more revenue and possibly even more cash, and yet the value of the company has diminished. That’s a bitter pill for a founder. I believe the generally downward valuation trend will continue in the early part of 2023. What happens in late 2023 will depend on a lot of factors and variables between now and then, so it’s hard for me to foresee. I do think it’s possible that as investors seek to deploy capital because they can’t sit on their cash indefinitely, the valuations of the “best” companies will start to increase before the broader market valuations increase. Said differently, investors will seek quality of investments over quantity of investments, and the most compelling companies may be able to attract capital at relatively higher valuations first.

Ken Woody, President and Partner, Innova: No, and no . . .  in more detail, we still see very strong downward pressure on funding rounds, even when the companies have made significant progress. It’s a buyer’s market right now, and many investors are being very cautious. If you want their money, you have to accept the aggressive terms.

David Adair, Co-Founder and Managing Partner, Solas BioVentures: The medical device/drug development market saw a dramatic 60 percent decline in value that bottomed out in May of 2022. For de-risked companies in select niche markets (cardiac, oncology, CNS), valuations remained stable, while some less “hot” areas have observed mild (i.e., 10 to 15 percent) declines in valuation. Development stage companies in need of capital are seeing more onerous terms and reduced pre-money valuations. In these situations, 30 to 40 percent discounts to the prior high-water marks are common. We believe this trend will continue at least through 2023. In summary, valuations in life science are multi-factorial. While the market and fundraising environment have caused some valuations to plummet, strong companies, with excellent management teams, data, and technology, will maintain or even increase their valuation.

Derren Burrell, Founder, President and General Partner, Veteran Ventures Capital: The valuation reset will continue in 2023, as the lofty valuations of 2020 and 2021 are firmly in the rearview mirror. It’s in the best interest of founders to have realistic expectations and keep their focus longer term rather than the first priced round that we tend to broker.

Eric Dobson, Chief Executive Officer, Sheltowee Angel Network: I believe that private equity valuations will decrease in 2023, and the average size of investment will also be because of concerns of a recession. That said, there we are nowhere near the bottom, and I don’t think we will get there. Several things boost valuation. We saw a decrease in the “also rans” and unprepared novices seeking capital starting in 2020, which unexpectedly drove valuations up in a sellers’ market. The deal flow since that time has been unprecedentedly good, and the founders we have met are savvy about what it takes to raise capital. We are just starting to see the novices coming back out. While I don’t see us getting to a buyer’s market in 2023, I expect to see valuations rationalizing.

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