Mean Reversion: When Will Startup Investing Return to Normal?
The post-Covid surge in venture capital pushed valuations & activity to record breaking heights. Since then, investing activity dropped precipitously.
When a collapse follows a surge, mean reversion suggests behavior should revert to a reasonable baseline. By building a linear model we can hazard a guess of when that might be.
The blue line shows actual Seed, A, & B activity by quarter. The red is a linear model based on data from 2010 to 2018 that predicts activity rates for each financing series of US & Canadian software companies. [1]
2021 & 2022 surged above prediction, while 2023 has operated meaningfully below - sometimes 50% below.
By looking at the cumulative rounds since 2010, we can see that Seed, A, & B volumes all trended meaningfully above their predicted counts. These rounds remain at elevated levels relative to the model’s expectation.
But the gap is narrowing.
At current trends, actual round counts should revert to the mean sometime in the second half of 2023. The model suggests we should see about 1000 Seeds, 240 Series As, & 65 Series Bs per quarter.
[1] The R^2 of these linear models are 0.86, 0.67, & 0.47 for the Seed, A, & B models.
Gonna dig in now. I'm just surprised by the recent $1B "seed" round... unheard of in 2023.
Customer Engagement Executive | SaaS CRM, ERP, No / Low Code, Cloud, Data & AI Platforms | Senior Sales Professional | Private Investor | #Outcomes
1 年Thanks Tomasz. Reversion to the mean certainly has tailwinds between AI enthusiasm and IPO markets thawing (ARM, Klaviyo, InstaCart). The linear model in the chart's timeframe though is a bit limited during an era of radically easy money policies (QE) and a generational low cost of capital (obviously excluding the past year). Are you seeing consideration of the forward slope shifting less steep with what many now envision as the end of a prolonged interest rate down cycle? Kyle Poyar how is your team thinking about this?
Caro Tomas che fine hai fatto in questi giorni
Entrepreneur, Investor, Business Process Innovator
1 年There is a pretty long list of factors that drive investing behavior in private markets. Mean reversion is undoubtedly real and a valid observation, but might be kinda hollow in this context when all we're measuring is investment rounds which are solely "buy-side" indicators. The notion of a mean reversion assumes that capital allocations to VC remain "normal" (read: constant and growing at the same pace). Is that sustainable as portfolios adjust for risk weighted returns? Meanwhile, feels like we're trying to apply public market theory which is a more honest indicator of investor sentiment (volume AND price on the buy AND sell side) to an illiquid market for VC. Who's creating the index that allows us to synthetically short this data set? It might allow us to more truly track mean reversion.
Founder & CEO of Upvest
1 年Thanks for sharing Tomasz Tunguz. Have you done a similar exercise for revenue multiples paid in A/B/Cs?