Last week we reviewed the financial year end for the Blackbird portfolio and communicated it to our investors.
As you would expect from the public markets, they are lower, but in this blog post we want to share in more detail the process by which we arrive at the estimates.
Our returns details have been updated on our website to reflect the latest reviews. In total, the dollar invested across all our funds achieved a 56% IRR and, best of all for us, a net multiple of invested capital (TVPI) of 4.4x.
It was brutal for technology companies in the public markets. After a decade of strong support for technology companies with a significant valuation increase in 2021, the past six months have seen this break. The Bessemer Cloud Index is down 54% from its peak and we are starting to see the impact of this wave in the venture capital ecosystem.
After all, the current market conditions have tested our valuation method. The tried and tested model in the last round of review just didn’t hold up. In response, we have made changes to strengthen our review process.
Venture capital has had a reputation for being a black box, but that’s not what we wanted at Blackbird at all and this blog is about our valuation methodology and how we’ve changed it given the current market conditions.
Why is the evaluation process important?
Blackbird is a long-term owner of our portfolio company. Our sole focus is to generate exceptional returns when we are ready to exit the investment in the coming years. Interim quarterly reviews will not affect this final result.
The quarterly reviews also have no direct economic impact on us at Blackbird. Sure, they brag to us, but we don’t pay based on the value of our portfolio, nor do we get any performance fees until we sell the property and return the capital to our investors. As Charlie Munger famously quipped, “Show me the motivation and I’ll show you the results.” We would love it if there were no such incentives in this process.
Despite all this, our quarterly reviews are very valuable to our investors.
Most of the capital we manage comes from Australian superannuation funds, which use our estimates as input to determine their unit prices. Unit prices are calculated daily and affect the contributions millions of their members make to the pension fund every time they receive their payment. So super funds and APRA (Financial System Regulator) valuations are fairly geared to reflect fair market value.
Venture capital valuation method
Valuing venture capital portfolios is generally based on a tried-and-tested valuation method: the final round of funding in which sophisticated third-party investors value a company for investment.
This is nothing new – the ‘last round’ price is the most widely accepted measure of the true value of a private tech company from San Francisco to Stockholm. It is certified by the Investment Council of Australia in accordance with International Private Equity and Venture Capital Valuation (IPEV) standards and audited by our investors, their advisors and auditors.
The venture capital world has adopted this rule because it is difficult to achieve excellence because it is objective, transparent, and transparent. Discounted cash flow models end reliance on heroic assumptions 10 years into the future. There is no public market that compares to a company with $500k in annual recurring revenue that triples year over year on the back of an evolving and rapidly iterative product, with a roadmap that is changing by the day.
Another thing about the ‘past round’ method is that we don’t evaluate our companies between financing rounds unless there is a deterioration in the company’s performance, which causes us to write down the company’s value.
We don’t mark companies as they grow, and we certainly don’t mark them as a public market rally. This means that when a company grows, valuation multiples are automatically reduced until another round of third-party funding is completed to reset the valuation.
This method has served us well for about ten years. In the regular market, our valuations often lag the public markets, ensuring valuations are generally conservative.
This has changed as we prepare for our June 2022 review process. Keeping prices at last year’s prices was not conservative, and it became clear that we needed to review our valuation methodology.
The decline in public tech companies in the first quarter was offset by the above-mentioned conservatism, as most companies grew to lower multiples. However, the relentless decline in prices in the second quarter resulted in a material difference between ‘last round’ carrying values and public comparisons. It was obvious that changes were needed.
For a fund manager like Blackbird, changing your valuation methodology is a big deal. As one smart investor told us, “Make sure any change you make is well thought out, repeatable year after year, and sustainable.” Routinely adjusting review policies does not create trust.
Therefore, changes to our valuation policy are well thought out after consultation with all our stakeholders, and pension funds and other investors, our auditors and of course our portfolio companies are concerned that the valuation is properly set.
Our new pricing policy
The new valuation policy divides the portfolio into two parts: (a) a basket of our late-stage portfolio companies, whose growth is comparable to their listed peers, and (b) a basket of early-stage companies that are still difficult to compete with in the public markets. .
For later stage companies, we don’t just use the ‘last round’ method. Instead, we mark to listed markets using market comparisons. We have them reviewed by a private external valuer at the end of each financial year to check our performance.
Although it may seem like a small change, it will have a big impact on the values of our portfolio. The power law of venture capital (a few companies generate most of the revenue) means that the later stage companies will be the majority of the portfolio value. This means that our valuation will fluctuate more than ever before in response to market movements and reflect fair market value.
For the rest of the portfolio, early-stage companies that are not easily comparable to public markets, we still think the ‘latest round’ valuation method is better. But as one time, for the June 2022 quarter, we have taken a further step. Given the market conditions, we have made provision on this part of the portfolio. This was a more blunt instrument: we looked at those valuations that were at very high risk and took an offer on them based on the decline in the public markets over the past nine months.
Both of these functions, which were released to our investors between July 21-29 and are now embedded in the pension fund segment’s pricing systems, were completed for our June 30 review.
We feel our portfolio valuations now fairly and transparently reflect the decline in listed technology company multiples, and our new policy will better prepare us to deal with volatility in the listed markets.
All of this has caused our portfolio’s total valuation to drop from $10B at the end of 2021 to $7.2B in June 2022. While valuations are lower than in the March quarter, they are still strong returns overall.
So we’re recession-proof. The price reduction reflects a change in market valuation parameters and does not diminish our enthusiasm for the future of our portfolio companies.
In total, the dollar invested across all our funds achieved a 56% IRR and, best of all for us, a net multiple of invested capital (TVPI) of 4.4x. Now is not the time to pat ourselves on the back – much of this is still unrealized, so it’s not an end result for our money, but a sign of progress this time around. Given the growth projections of our major companies, we don’t have to look too far ahead to see that total value grow above the $10B mark and beyond.
While a lot has changed in the past 12 months, we’ve been investing in early-stage companies and have been privileged to support the best founders for decades. Market conditions change, prices go up and down, but a generational company of last year is still a generational company today and we will never stop looking for those companies.
We remain optimistic about founders in Australia and New Zealand. If you have a good business, please get in touch. We invest from the very beginning (we supported Canva at the idea stage) so nothing is too early and no investment is too small.
* This post originally appeared on the Blackbird Blog. You can read the original here.