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Klarna’s down round is early indicator of pain in private markets

Private equity is set to play a bigger role in fintech, writes Professor Florin Vasvari, Academic Director at the Institute of Entrepreneurship and Private Capital at the London Business School.

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For a while fintechs looked invincible: overcoming all hurdles and attracting mega rounds of funding. However, the news that Klarna’s value has been slashed from $46bn to $6.5bn in its forthcoming fundraise, shows that even the biggest stars of the private markets are going to feel pain.

Public market companies have already felt the pain of soaring inflation, as central banks continue to pump interest rates higher. The S&P 500 has had its worst first half for more than 50 years and the tech-heavy Nasdaq is down 30 per cent this year. Private market companies will inevitably catch up, London Business School’s Private Capital symposium heard last week, albeit some months later.

Looking at the drop in the valuations of venture or buyout backed companies listed over the last two years - a good benchmark for valuations of private companies -  does not bode well. According to Pitchbook venture backed IPOs are down 52 per cent, while buyout backed IPOs are down by 32 per cent - this is a steeper fall even than the S&P 500 since the beginning of the year.

So far, down rounds have been few and far between: in the first quarter of 2022 only 5 per cent of completed rounds have come in at a lower valuation than when companies last raised capital. However, the news that Klarna, which became Europe’s most valued startup last March, is about to raise fresh capital at a valuation of about $6.5bn, having been valued at $46bn last year, shows that even the biggest stars of the private markets are going to feel pain.

It is too early to tell how badly affected the venture capital sector could be in the next 12 to 18 months. But the belt tightening will put a new level of pressure on both investors and founders, many of whom have never seen a downturn.  

Tech company fundraising

Inflation is also likely to lead to some contraction in fundraising. As capital becomes more expensive, investors will be pickier and take longer over due diligence. When portfolio companies’ valuations finally adjust, some limited partners might find themselves overallocated to alternative assets and thus in need to cut down their exposure to private funds. 

In addition, distributions from funds will likely slow down, limiting what capital investors have available for new commitments. Exits via M&A or IPOs are also going to be less common. Since IPO markets are effectively closed, fund managers will choose to hold onto portfolio companies for longer. And if exits are necessary, they will come at much lower valuations. 

Buyout fund role 

Buyout funds should be less sensitive to rising discount rates than venture capital portfolios but most buyout transactions are financed with floating-rate debt, thus many portfolio companies will need to cover increasing interest payments at a time when earnings remain under pressure from economic contraction and strained supply chains. 

This means that as interest rates rise to tamper down inflation, defaults could accelerate. Unlike in the global financial crisis, the lenders which are often private debt funds and other institutional funds are more likely to enforce their debt contracts than the commercial banks who were reluctant to intervene in 2008.  

But another factor to bear in mind is that buyout fund managers have been increasingly finding their way into tech deals, under pressure from institutions  who wanted earlier exposure to tech, before it reaches public markets. The likes of KKR (Zwift), Blackstone (recently backed SumUp) and Tiger Global (MoonPay and Checkout.com) have invested heavily in some of the fastest-growing tech companies and have also raised dedicated venture capital funds. 

Those who doubt that PE houses have the skills to grow businesses - as opposed to improving metrics by cost cutting and asset-stripping - should understand that the specialist knowledge that is needed has been brought in via whole teams of tech investors. KKR’s tech growth fund team has recently poached professionals from tech focused managers such as Salesforce Ventures or Silver Lake. 

Time to commit

As we face a turbulent period, private equity’s role in the midst of this market adjustment could turn out to be crucial. The commitment (and capital) of venture and buyout fund managers could just take the edge off the violent adjustment experienced by stocks in the public markets.

Given the substantial amount of dry powder still available in private markets, which reached close to $1trn at the end of 2021, and the potentially superior governance model in private markets, these managers could be well-positioned to weather this volatile environment. 

The markets might be delivering on private fund managers' number one wish: lower valuations when deploying the capital.

The views and opinions expressed are not necessarily those of AltFi.

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