Summary of NFC's 2023 Annual LP Meeting

On October 27th, an exceptionally cold and snowy autumn day in Bozeman, Next Frontier Capital held its Annual Meeting, for a discussion with our Limited Partners (LPs). Each year, we gather to discuss our views on market development, portfolio performance, and changes in our Firm. Looking back, 2023 proved to be a year of transition. Transition into a new macroeconomic regime, one of higher interest rates, transition into a new venture hype cycle, generative AI, and transition into a period where capital formation for both managers and companies is more challenging. Despite these transitions, our core thesis remains intact, and we expect many companies of global impact will be founded in the Rocky Mountains over the coming decade, as more and more people choose this region as their home and place of work. 

A New Regime

Financial markets have had over a year to price in the new reality of higher interest rates. The brisk hiking cycle of the U.S. Federal Reserve beginning in the beginning of 2022 had an immediate effect on valuations in the public markets, with enterprise value to ARR multiples for software companies falling from high teens to between 6-7x, where they still stand today. This new regime has led to a significant pullback in deployment of capital in venture, as uncertainty pervades investment committee conversations around the country. Pitchbook estimates $244B was invested in U.S. VC in 2022 across 17,498 deals, down from $347B across 18,926 deals in 2021. Through the third quarter of 2023, just $126B had been invested across 9,962 deals. 

Caution in venture deployment has changed the dynamics of boardroom discussions at venture backed companies. With future financings much less certain, runway extension, profitability, and efficiency are back in vogue. Delivering durable growth is necessary to attract follow-on capital. It’s not just financing that is more challenging for startups. The procurement environment is also difficult. Anecdotally, we have heard from many companies both in and outside of NFC’s portfolio that deals are harder to close. Enterprises have tightened belts, consolidating spend where possible and slowing net new procurement. This has led to longer sales cycles and increased payback periods. Meritech estimates payback periods have increased 74% over the past two years for public software companies, moving to 30.7 months in Q2 of 2023, from 17.6 months in Q2 of 2021. Startups must deliver products that are 10x better than incumbent solutions to drive healthy top line growth. 

Pricing Divergence

Venture firms were able to raise enormous pools of capital in 2021 and 2022. It’s a different story in 2023. After the year is out, venture firms will likely have raised 50% less relative to 2021 and 2022, at or below levels seen before the frenetic period of 2021 and 2022. 

This deluge of capital drove valuations to levels totally divorced from the fundamentals of the businesses they were attached to. Growth stage valuations, as tracked by Pitchbook, were 3.3x higher in 2021 than 2017. In 2022 and 2023, growth stage valuations fell off a cliff, down 60% from peaks, and settling just 1.1x higher than in 2017. Interestingly, earlier stage valuations have not contracted, and are still high relative to history. Seed stage valuations in 2023 are 2.1x higher than in 2017. Why has this trend held? First, earlier stage company valuations are always later to respond to changes in macroeconomic conditions, relative to their later stage peers. Second, today there are multi-stage venture funds with multi-billion dollar pools of capital wanting access to the best seed stage deals, and they are willing to be far less price sensitive than firms exclusively making investments at the early stage. 

We believe early stage pricing will eventually respond, and come down in line with historical trends. Pitchbook publishes a capital demand to supply ratio, estimating the balance between capital demanded by startups and capital supplied by investors. Its index value is far higher than it has been in the past five years, evidence of downward pressure on valuations. While it may take another year for early stage companies to recognize the new environment and accept market pricing in new deals, we believe this will happen over the coming 12-24 months. 

Bright Spots

One thing 2023 didn’t see much of was liquidity. The exit environment for VC backed startups was markedly different from 2021. Pitchbook estimates there were 1,979 exits of VC backed startups with a total value of $795B in 2021. That value collapsed an order of magnitude to just $77B in 2022, and it looks like exit values will be similar in 2023. In spite of the dismal environment for exits in 2023, we were thrilled to announce in March that NFC Fund II portfolio company Aumni was acquired by JPMorganChase JP Morgan stepped up in the wake of the Silicon Valley Bank collapse to invest in a technology that will serve as a key pillar of their private market solutions initiatives. This is a great outcome for the Salt Lake City based company, which will continue to operate out of Utah. 

Tribute to a Giant of MT 

This year, after a hard fought battle with colon cancer, we lost Michael FitzGerald, a pioneer in the Montana technology ecosystem.

A celebrated author, he co-founded Submittable in 2010 in Missoula as a submission management platform. He was the first founder of a Montana company to get into YCombinator. His company recently raised a $47M Series C, which at the time was the largest growth equity financing in Montana history. His company has created hundreds of jobs, dozens in Missoula, and today is a social impact platform for governments, corporations, and foundations and endowments. This year, we started a new tradition, suggested by NFC GP Les Craig. From this year forward, we will present the Michael FitzGerald Entrepreneurial Award to a person from an NFC portfolio company who exemplifies the values which made Michael FitzGerald a cornerstone of his community: grit, humility, resilience, balance, humor, and vision. This year, Aumni co-founder and CEO Tony Lewis was the awardee.

Tony shepherded Aumni through difficult market conditions to consummate its sale to JP Morgan in March. Tony was many of those things. He was resilient through hardship, gritty through tumult, and executed relentlessly against his vision of the future, one in which Aumni will play a central role in building liquidity in the private markets.