How Market Volatility Is Spurring A Shift To Private Markets For Startup Investment

The year 2022 brought with it unexpected market turmoil, geopolitical instability, and economic uncertainty. Certain geopolitical factors, such as the Russia-Ukraine conflict, the ensuing energy crisis in Europe, rising global inflation, and interest rate hikes by the central banks have remained major concerns. In addition, the recent cracks within the banking sector, notably at SVB and Credit Suisse, have further exacerbated the economic landscape.

But all is not doom and gloom in the broader scenario concerning private markets. As of 2022, the amount of dry powder available in both private equity and private credit is more than $1 Tn as reported by Preqin. This suggests that many companies should continue to have access to private funding even during a downturn.

Studies have shown that private markets have become increasingly popular among private investment firms due to their ability to diversify portfolios and provide higher returns than public markets. As we look ahead to 2023, it is worth exploring the outlook for private markets in more detail.

Private Markets In The Face Of Market Uncertainty

Although the uncertainty surrounding the current economic environment seems to continue into 2023, we maintain a cautiously optimistic outlook for the year. The good news is that while inflation-recession cycles lead to uncertainty, there are opportunities to continue investing in long-term megatrends such as the transition to a green/low-carbon economy, accelerating technology adoption, and demographic shifts in emerging markets.

The ongoing concerns about the global economic slowdown last year contributed to significant declines in public equities. By contrast, private markets are yet to react/correct in the same order. Private equity valuations experienced less severe declines, whereas private credit valuations presented opportunities for higher yields. Furthermore, we see more and more companies turning to private markets for their capital and financing needs, increasing the potential investment opportunities, which is one of the reasons driving our optimism as we foresee the year 2023.

Private Debt Continues To Soar

Private debt, which took off since the global financial crisis with just $500 Mn a decade ago, has now soared to more than $1.2 Tn by the end of 2021, according to Preqin. The category is the fastest growing among private investments, and forecasts expect it to reach $2.3 Tn by 2027. Private debt is expected to continue to expand as public/bank financing retreats and more companies seek capital.

The performance of the private debt market is likely to remain robust regardless of the ongoing inflationary environment. This is because the asset class offers a range of diversified strategies that can perform well in a variety of market environments, produce higher yield premiums in rising-rate environments, and generate contractual returns. As a result, it can be anticipated that the allocations in private debt will continue to surge.

Technology & Data: The Game Changers For Private Markets

In terms of technology and data proliferation, the private markets industry is slowly advancing to a new level of maturity. The transformation to a better technology ecosystem for the industry is well underway, as it offers many benefits, such as proactive risk monitoring, portfolio surveillance, streamlining the enormous amount of data to deliver timely insights, and meeting strict regulatory and investor requirements — all within a unified technology ecosystem, helping the firms that proactively embrace this shift.

In 2023, the world’s leading investment firms will continue to prioritise their allocations to new-age digital technologies and seek out progressive technology partners who are leveraging new digitalised and scalable technologies that significantly optimise costs and time to market and create meaningful operational efficiencies for investment managers and investors alike.

Private Markets Have Been The Backbone Of The Growth Story Of Startups

As the startup world continues to evolve, founders are presented with a plethora of funding choices. These options range from bootstrapping, raising equity, or pursuing non-dilutive debt capital. Private markets have played a crucial role in the success of many startups, offering founders a viable alternative to achieve their growth potential amidst a constantly changing landscape. However, due to a liquidity crunch in the market, many founders are now turning to bootstrapping as a more stable and reliable option. In fact, the success of several prominent bootstrapped companies has led to an increase in the consideration of this approach as a compelling alternative.

Bootstrapped founders, for instance, enjoy greater flexibility in terms of decision-making and resource allocation, which enables them to navigate economic slowdowns more easily. In contrast, VC-backed startups face increased pressure to meet investor-designated targets, which can be challenging in times of economic downturns and inflationary periods. Recent trends indicate that VC-backed startups are struggling to keep their businesses afloat, with many resorting to layoffs and cost-cutting measures, whereas bootstrapped startups have proven to be going strong with no such downsizing measures. In fact, many bootstrapped tech startups have better hiring prospects even as they successfully navigate economic downturns.

2023 And Beyond

While navigating the uncertain markets in 2022 proved challenging for many, it also presented a host of opportunities for alternatives. As estimated by the Mckinsey Global Institute, upgrading the world’s infrastructure will likely require a staggering $69 Tn by the year 2030 to keep up with projected global demand, and private funding is expected to play a significant role in meeting these infrastructure spending requirements in the coming years.

Additionally, there are long-term opportunities in private markets as the underlying asset classes are rapidly evolving, with private debt slowly coming of age, trailing only behind private equity. The resilience of private markets will be put to the test in the coming years, and given the nuanced nature of private markets, technology and data will prove to be game changers for investment managers to make informed decisions and capitalise on these growth opportunities.

Even though the underlying fundamentals remain robust, the current macroeconomic factors and recent banking issues indicate that economic uncertainty is likely to persist and contribute to investor woes. Therefore, investors should be mindful of the potential risks and carefully evaluate their investment exposure. Overall, the private markets are expected to continue to perform well in the coming year, but with a more cautious and selective approach.