Global growth equity fund General Atlantic chief executive officer Bill Ford is not surprised by the bubble that has been created in the tech market in recent years. As somebody who has been working with the biggest Wall Street investment institutions over the past 15 years in his current position, he found that what has been happening over the past two years may have been unusual but has also not been entirely surprising.
"Look at what happened in 2000 - every time there is a rise in share prices on the stock exchange, there are many institutions that enter the private equity and venture capital sector but many of them like hedge funds, and family offices, don't mean to stay over the long run. I call them 'tourists' who enter the market when it seems attractive and the moment it starts falling, then they leave," Ford tells "Globes" in his first interview with the Israeli media.
Ford is currently making his first visit to Israel as part of General Atlantic's global expansion, which includes inaugurating the fund's Tel Aviv office, (which opened in April). "The fact is that it is expected. New investors come into a bullish market and retreat from a bear market because it's not their main business, or they are not sufficiently committed to it. When we talk with our companies, we tell them that we are here with them for the long run, with a lot of patience, and we are prepared to be here when the markets are good and when they are bad."
General Atlantic has been active in Israel since the end of 2019 and despite avoiding media attention on its activities in the country, it has already made eight huge investments totaling $750 million, five of which were during what we can now call the "Covid bubble," when company valuations were higher than usual. Investments in Israel are led by Alex Crisses and Anton Levy, alongside Max August who helps identify local companies. Investments by General Atlantic in Israel are in Riskified, Appsflyer, ZoomIn, Transmit Security, Atera, Vast Data, Hibob and Fireblocks.
General Atlantic has kept a lower profile in Israel than other huge investment funds that have invested heavily in local tech growth companies like Insight Partners and Tiger Global, although it is of a similar size to them. Tiger Global has $96 billion under management, Insight has $90 billion under management, and General Atlantic has $79 billion under management.
Ford recounts, "The past two years have been the most difficult years to differentiate between our capital and that of other investors. An entrepreneur would say, 'I want to raise capital at this price,' and they would immediately receive an agreement of understanding ahead of the financing round. They caused hedge funds that came from outside to agree to these offers and the prices became irrational. Now we have moved to a more constructive period, entrepreneurs' requests for money have become more rational."
It seems that everyone is waiting to see what is happening in the market and asking themselves if the bottom has been reached
We informed our investors at an investors meeting that we held in London that we were moving to a new investment regime. What did we mean? If you look at the 12 or 13 years that have passed since the previous financial crisis, central banks around the world have provided many financial incentives to ensure that the economy keeps moving. Central Banks in Europe, the US, and Japan injected $25 trillion of financial incentives during this period of time and the markets did indeed strengthen. So we had at the start amazingly low inflation and low interest rates but the prices of assets reached record heights - from real estate to the stock exchange and cryptocurrencies. Now because of high inflation, interest rates are rising and rising and the central banks are in practice pulling liquidity out of the market and shifting from loosening to tightening. In all this many assets are being repriced and in this environment the possibility of a recession has been introduced because of monetary tightening and the need to fight inflation.
"Most of us have never experienced an economic environment like this - an environment of high inflation, high interest rates, and the possibility of a recession - but it's possible that this wil be the situation we are caught in for some time. While this is a challenging environment, it is also one that highlights our strengths. It allows us to stand out as long-term investors. Many of the institutions that came to the tech market didn't really have the ability to help companies but mainly carried out many investments, and operated in a rather passive way, and in practice gave no shape to the businesses in any way. Our capital, on the other hand, is all about patience, genuine partnership with the entrepreneurs, long-term commitment to help the companies to grow, and create value. Therefore, I think that this challenging environment will better reveal the differences between the various types of investors."
You say that you entered a new investment regime. What did you advise you entrepreneurs to do?
"We support our companies on this issue beyond the usual involvement that we have with them as members of the board of directors and active partners. There we advise companies to act in a number of areas: the first is to prepare to extend the amount of time in which they planned to operate with their current budget and to better preserve their capital. This can be done by reducing costs or by reducing the rate of using resources. The good news is that many companies, including our portfolio companies, have raised a lot of capital over the past two years. Now they need to prepare to spread this amount over two or three years by managing costs more wisely.
"The second piece of advice is to learn to play offensively and this can be done in two ways: by initiating mergers and acquisitions and by acquiring talent. After all there have been too many companies created here and there is a need for consolidation. For companies leading their markets there is an opportunity to work on this front in order to strengthen their status in the market and reduce the number of rivals. Regarding acquiring talent, we are entering a reality in which companies with excellent employees will begin to fail, and there will be possibilities to implement steps to hire them to your organization. There was here a period in which capital brought about the creation of too many companies, so that too many companies raised capital and the valuations were too high - companies raised money because they could and not because there was a need. Now we are moving to an environment in which capital will be more difficult to obtain and it will come in smaller amounts. Company creation will become more challenging."
Do you not think that private equity funds also bear some responsibility on the matter?
"When the real and absolute interest rate is very low, the same institutions that previously held bonds as a way of producing returns and meeting their commitments to pension funds or university endowment funds could no longer generate there returns because of the low rates. They turned to alternative investments, and private equity is one of their most valued directions. But what 20 years ago would have reached a maximum of $1 trillion in assets now became $10 trillion of assets and all this money sought deals and raised prices. Now you are getting the opposite effect with a lot of these institutions cutting their commitments to private equity, going off in different directions, and leaving very selected activities and supporting a smaller number of companies. A large amount of the capital that was not committed for the long term will also leave - perhaps this provides an explanation for the situation in which we find ourselves in which the amount of money that was in the market was so large."
General Atlantic is a veteran fund that has been operating as a growth fund since 1980 by investing in companies that have already generated revenue and are growing rapidly, by at least 40% annually, in areas like technology and also life sciences, consumer products, and finance. General Atlantic's exits include Airbnb, Buzzfeed and e-commerce company Wish. It has written checks for up to $800 million for individual investments but can also see investment opportunities in earlier stage companies if they are already producing revenue, and will sometimes invest $25 or $50 million in Series B financing rounds, and this kind of investment is more relevant for Israeli companies.
Most returns for investment funds in the tech sector in the past two years were on paper and they saw the big falls start back in the summer of 2021. Did you already see the bubble beginning to burst back then?
"We have been saying for four or five years that the valuations of companies was too high. Because of this we were focused during this period more on exits and creating returns in cash for our investors and working cautiously overall on new investments. If you look at our portfolio, you will see that in total in each of the last three or four years, we sold more than we in the end invested.
"But this pattern is beginning to change. The ability to achieve better performances is more difficult and the IPO market is closed at a time when prices are falling relatively fast. This creates new investment opportunities on more attractive terms. So after five years, we will begin to make more investments and maybe we will see a little less of our holdings. This is a significant shift. Of course, it will become clear that we made such and such mistakes but it will also become clear that our overall investment strategy and our sales were correct."
According to research by PitchBook, the rate of exits by private equity funds reached really low levels. Does that mean you will take advantage of the situation for long-term and perhaps more risky investments?
"The area in which we receive high marks from investors is that we created during this period so much liquidity, and in practice we actually took the money off the table while many of our rivals has unrealized profits, only on paper. They didn't repay capital to investors on time and now when the companies' valuations are falling they are very much regretting this. In other words, not only are real returns falling, but this is also on paper, and investors are coming to them and asking why they had not paid them back money while they could. Now, two, three or even four years will have to go by before until we receive significant returns on the capital that we have invested."
Falls in the valuations of publicly-traded companies is expected to also be expressed in privately-held tech companies and unicorns and cause companies to expect funds that they will raise to be at a lower valuation than the previous financing round - this might create major embarrassment for them and cause chaos in the relations between entrepreneurs, investors and employees.
"This will happen but perhaps more slowly, like sliding down a slope in low gear. The reason that this will happen in low gear is the fact that money companies raised significant amounts in the past two or three years and their financial indices are firm and the path that they are taking is clear. Usually companies are forced to cut their valuation when they are in a situation that they are entering the dangerous area where they have capital at their disposal that will last them less than a year to finance their operating losses. Only then will they need to receive financing at a lower valuation.
"What we are seeing now in considerable numbers is entrepreneurs who raised capital, including capital that they raised from the players who entered tech investment for the short term, and played in very, very high price ranges, and those entrepreneurs are looking for a new partner that will support them for the long term. They are talking about coming in for investments at last year's prices, a flat round, while they succeed in producing a stable way forward in terms of economic growth. I would say bluntly, that many of these investment opportunities are still at a fairly exorbitant price, even taking into account that these companies will still grow over the next year. So I think that this will take time but eventually we will reach a time when companies will begin to raise capital at a lower valuation."
The number of layoffs in June has reached numbers that we saw during the outbreak of the Covid pandemic
"We are entering a period of turmoil that will include many mergers and acquisitions in our industry. Too many companies were financed by venture capital funds in many markets. In every area we should have seen maybe three or four competitors. Instead there are seven. Not all of them will succeed and some of them will certainly close down and their employees will be thrown onto the market. In other cases, there will maybe be mergers but also then there will be layoffs. I think that it is almost inevitable and it has already begun to happen. It's possible that it will take time until this turmoil is expressed and these mergers will happen, because many of these companies still have a lot of capital that they raised during the period of abundance. It will probably take a lot of time until they need to really recognize the fact that they need to undergo these processes."
Investors are fleeing shares and technology for other assets like real estate, bonds, or commodities. Do you see a trend in which they are returning to technology investments?
"Firstly, there is still strong growth that comes from the technology market, and if you invest in an area for the long term, the returns have proven themselves over time. There are many tech shares that are demonstrating strong growth even in the bear market and generally, overall growth is not related to short term cycles in economics. In the short term, however, we see more investors flocking to holding debt because of the rise in interest rates and this is something we did not see until the last three months."
When in your opinion will shares again be a sought after commodity?
"At the moment there are still some things missing that make this difficult, and until we receive an answer about them, we will not know for certain when they will be back. For example, what are reasonable rates of rises in inflation and interest rates? Are we heading for a recession? The bear market that we have entered and the low revenue multiples reflect the interest rate and high inflation. But what will happen if we begin to see the fall in the markets expressed in the company's reports that have not at all taken into account a recession and they will report on revenue falls. The harm to revenue and profits will lead to even bigger losses on the stock exchange, and so there are some answers that investors are waiting to receive before they commit to allocating more capital to the stock market."
With the crisis in the market, it seems that investors now have the upper hand, after two years that gave entrepreneurs the clear advantage in raising capital.
Absolutely. Firstly, we have returned to a period in which it is possible to undertake full due diligence before the investment. Over the past year we saw entrepreneurs that were drawing up investment agreements with an ultimatum of 24 hours and offering potential investors the option of the most limited due diligence. We have never compromised on this and now we see that this pressure has ended. The terms of the deal have also become more convenient. If until recently they would offer us shares with very restricted rights, today we have returned to a period in which investors can acquire senior shares with preferential rights and protections. If until recently financing rounds came down to the entrepreneur wanting to raise at a valuation of 43 billion and he would wait until somebody turned up with the money, today the financing rounds are again based on growth, profitability and cash flow, and valuations have returned to be their natural size."
Israel is an expensive country, also for venture capital investors, and apparently the investment funds keep coming here and rasing prices. Are you part of this trend?
"It's true that many investors have come here because of the innovation that has been created and they have certainly reflected the way they think in valuation estimates. This is a wonderful thing for Israel, of course, but there will be the need to let the heat out of the market so that prices will be rather more rational."
Will you invest in cryptocurrency or blockchain companies in light of the market upheaval?
"We do not invest in cryptocurrencies but in companies, despite the major correction in cryptocurrencies, the long term trend that belongs to blockchain, to financial dispersal and web 3.0 is very genuine and represents a new computerized infrastructure around which good companies are created. I think that the currency market upheaval leaves genuine investors in the field."
Published by Globes, Israel business news - en.globes.co.il - on June 26, 2022.
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