Last week, we finalized our fiscal year-end valuations for the Blackbird portfolio and communicated it to our investors.
They have fallen as you would expect in the light of the public markets, but with this blog post we wanted to share in more detail the process we used to arrive at the valuations.
The details of our returns have been updated on our website to display the latest ratings. In total, one dollar invested in all of our funds has yielded an IRR of 56% and more importantly, for us a net multiple of invested capital (TVPI) of 4.4x.
It has been brutal for technology companies in the public markets. After a decade of strong support for tech companies, culminating in a massive wave of valuation surges in 2021, things have calmed down over the past six months. The Bessemer Cloud Index is down 54% from its peak and we are starting to see the effects of this ripple through the venture capital ecosystem.
More importantly, the current market situation has put our valuation methodology to the test. The tried and tested model of reliance on valuation in the last round has not held up as it did before. In response, we made changes to strengthen our valuation process.
Venture capital has a reputation for being a black box, but this is never something we wanted at Blackbird and so this blog is all about our valuation methodology and how we’ve changed it to take into account the current market situation.
Why is the valuation process important?
Blackbird is a long-term holder of our portfolio companies. Our sole focus is to create exceptional returns by the time we are ready to exit our investments in the coming years. The interim quarterly valuations have no influence on this final outcome.
The quarterly valuations also have no direct economic effect on us at Blackbird. Sure, they give us bragging rights, but we don’t get any fees based on the value of our portfolio, nor do we get any performance fees until we’ve sold the assets and returned the capital to our investors. As Charlie Munger famously said, “Show me the incentive and I’ll show you the outcome”. We love that there are no such incentives in this process.
Despite all this, our quarterly valuations are very important to our investors.
Most of the capital we manage comes from Australian pension funds, who use our valuations as input to determine their unit prices. The unit prices are calculated daily and affect the contributions of millions of their members who buy into a pension fund every time they receive their wages. Thus, the super-funds and APRA (the regulator of the financial system) are rightly focused on ensuring that valuations reflect fair market value.
Venture Capital Valuation Methodology
Determining the valuation of venture capital portfolios is generally based on a proven valuation method: the final round of financing where sophisticated third-party investors set the price to invest capital in a company.
This is nothing new – ‘last round’ pricing is the most widely accepted measure of the fair value of a private technology company from San Francisco to Stockholm. It is based on the International Private Equity and Venture Capital Valuation (IPEV) standards, approved by the Australian Investment Council and audited by our investors, their advisors and our auditors.
The venture capital world eventually adopted this standard because it’s objective and easily observable and frankly because it’s hard to find anything superior. Discounted cash flow models ultimately rely on heroic assumptions 10 years into the future. There are no public markets that compare to a company with $500K in annual recurring revenue that triples year after year thanks to a product that is rapidly improving and repeating itself, with a roadmap that changes day by day.
The other aspect of the ‘last round’ methodology is that we do not revalue our companies between funding rounds unless there is a deterioration in the company’s performance that would cause us to write off company value.
We don’t mark companies as they grow and we certainly don’t mark them as a public markets rally. This means that as a company grows, the valuation multiples automatically decrease, until another third-party financing round is completed to reset the price.
This method has served us very well for ten years. In a normal market, this means that our valuations usually lag public markets, so valuations are generally conservative.
As we prepared for our June 2022 valuation process, this had changed. Holding valuations to last year’s prices was no longer conservative and it became clear that we needed to revise our valuation methodology.
The decline in public technology companies in the first quarter was offset by the conservatism outlined above, as most companies had grown to lower multiples. However, continued declining prices in the second quarter resulted in a material difference between the ‘last round’ book value and the publicly available comparables. It was clear that changes were needed.
For a fund manager like Blackbird it is important to change your valuation method. As one wise investor told us, “Make sure any changes you make are well thought out, repeatable year after year, and built to last”. Regularly adjusting the valuation policy does not build trust.
The changes to our valuation policy are therefore well thought out after consultation with all our stakeholders: the pension funds and our other investors, our accountants and of course our portfolio companies, who are also concerned that valuations are determined fairly.
Our new valuation policy
The new valuation policy splits the portfolio into two: (a) a basket of our late-stage portfolio companies, whose progress can be compared to listed peers, and (b) a basket of earlier-stage companies that are still inherently difficult to compare. are with public markets.
For the companies in the later phase, we will no longer only use the ‘last round’ methodology. Instead, we highlight them in listed markets using market comparisons. In order to check our operation, we also have them appraised independently by an external appraiser at the end of each financial year.
While it may seem like a small change, it will have a major effect on our portfolio’s valuations. The power law of venture capital (a small number of companies yield the most returns) means that the later stage companies usually make up the bulk of the portfolio value. It will mean that our valuations will fluctuate more than before in response to quoted market movements and it will result in a more accurate reflection of fair market value.
For the rest of the portfolio, the early stage companies that are not easily comparable to the public markets, we still think the ‘last round’ valuation method is the best. But for the June 2022 quarter, we took an extra step once. In view of the extreme market conditions, we have formed a provision for this part of the portfolio. This was a more blunt instrument: we looked at those valuations that were threatening to be too high and provisioned them based on the decline in public markets over the past nine months.
Both actions have now been completed for our June 30 valuations, which were released to our investors over the July 21-29 period and have now flowed through the pension funds’ unit pricing systems.
We believe that our portfolio valuations now reflect the decline in the multiples of listed technology companies in a fair and transparent manner, and our new policies allow us to better manage volatility in listed markets.
Look forward to something
All of this has resulted in the total valuation of our portfolio falling from $10 billion at the end of 2021 to $7.2 billion at the end of June 2022. While valuations are lower than in the March quarter, overall they are still strong. returns.
We are optimistic about this decline. The decline in holding value reflects the market’s change in valuation metrics, not a diminution in our enthusiasm for the future of our portfolio companies.
In total, one dollar invested in all of our funds has yielded an IRR of 56% and more importantly, for us a net multiple of invested capital (TVPI) of 4.4x. It’s not a time to pat ourselves on the back – the vast majority of this has not yet been achieved, so at this point it’s progress rather than the end result for our funds. Given the growth forecasts of our top companies, we don’t need to look too far into the future to see aggregate valuation rise above $10 billion and beyond.
While a lot has changed in the last 12 months, we still invest in generation companies from the beginning and earn the right to support the best founders for decades. Market conditions will change, prices will go up and down, but a generation company last year is still a generation company today and we will not stop looking for those companies.
We still remain unboundedly optimistic about founders in Australia and New Zealand. Do you have a nice company, please contact us. We invest from the start (we supported Canva in the idea phase), so nothing is too early and no investment is too small.