Lux Capital Founder & Managing Director Josh Wolfe joins Yahoo Finance Live to discuss venture capital (VC) investing trends and the outlook for tech stocks.
Video Transcript
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JULIE HYMAN: Well, we have seen tech stocks really get hit this year. The NASDAQ the big underperformer when it comes to the major averages. And we have seen a lot of talk about tech valuations. That has extended by the way, not just in the public markets but in the private markets when it comes to valuations as well.
Let’s talk more about that with Josh Wolfe, founder and managing director of Lux Capital. Josh, thanks for being here. What have you made of all of this turmoil that we have seen within public-facing tech shares? And what has that meant for valuations in the private space also?
JOSH WOLFE: Well, my own view, which is a bit dark, is that we are probably in March of 2000 and we’ve got an 18-month period where you might see 50 basis points to 1% declines. And that’s basically the slow decay of people’s belief in what historically has been rah-rah growth mode. So the first thing I would say, which is the admonishment that we are telling our companies, is for the people who have been fortunate, whether through IPOs or SPACs, equity issuances, debt, whatever it might be, is husband your cash. Use that cash wisely. I think we’re going to be in for some tumultuous times. And the people that are going to be able to consolidate their industry positions are the ones that are going to emerge as the winners. So that’s the first thing I say.
The second thing is I think you’re going to have some really interesting market structural changes. There’s early evidence that we’re seeing this when you have Facebook have its one– the all-time historic $250 billion loss of market value, and then within a day you see, Amazon see its greatest– or the market’s greatest $119-plus billion ascension. You see Snap going down 24% in one day, and then back up 50% the next.
That volatility is indicative of market structure changes, of going from passive indexation into active investors, from people who might be highly levered into liquidating those positions, from retail investors, into institutional, from momentum and growth investors into value investors. So I think we’re going to see a lot of change over the next six months or 12 months. And I think it’s critical that people husband their cash.
JULIE HYMAN: And how are you seeing that in your sort of day-to-day or week-to-week business? What sort of signs are you seeing that are making you send these caution signs to your portfolio of companies?
JOSH WOLFE: Well, oftentimes almost like that Sherlock Holmes story of the ‘Curious Incident of the Dog in the Night’ it’s the sound that you don’t hear. So what has been noticeably absent for most of our Monday and Thursday partner meetings at our venture fund has been bad news. And the absence of bad news is bad news. You know, you want to hear that there are struggles, that there are issues that are happening. You want to hear that many of the great companies that you’ve backed, suddenly there’s RIFs, reductions-in-force, layoffs. They’re struggling to have a down round. There might be an issue with a CEO, there might be a coup of an engineering team that wants to replace management.
Those are signs of healthy functional change. When everything is up and to the right, and all of our companies are doing phenomenally well, it’s like when your kids are in the bedroom and you don’t hear any noise, it’s a little bit time to worry. So the signs for us are the absence of the signs, which portend that you’re going to have some perilous moments.
You’re starting to see capital go from extremely abundant and the cost of capital very low, and valuations very high, to the opposite. You’re starting to see a scale-back from late-stage growth investors, from crossover hedge funds, you’re starting to see allocators, which are the LPs who give us and other people money, see a denominator effect, which in simple terms means all the money that they put into VC and private equity and public funds, when the public funds are getting hit, and some of these stock names are down 50% or more, suddenly they’re overweighted in private equity and they need to start thinking, hey, how do we reduce exposure to venture and private equity? Harder to do with an illiquid asset class, also probably going to create a lot of dislocations.
BRIAN SOZZI: Josh, just given the sell-off we have seen in tech, has that impacted the culture inside of these very innovative companies? Because as you know, a lot of times these next-generation tech executives are compensated in options.
JOSH WOLFE: Indeed. You know, first, you’ve got comps in the public markets that often dictate what valuations are in the private markets. Now, the private markets on the way up lag the public markets. But I think you’re going to see the same thing on the way down, they will lag, in part because of that illiquidity I was just talking about. You know, the cultural mindset when you’re issued stock at the ground floor of a company, as that company ascends, and you have subsequent financing rounds, and those financing rounds are ever higher, life is great.
When you start to have down rounds, which I have to tell you in about 10 years you really haven’t seen companies, and you haven’t seen a generation of people that have really experienced permanent capital loss, you know, that great definition of risk, permanent loss of capital. And so I think that you’re going to have a shakeout. I think you’re going to have a reduction in the number of venture firms. I think you’re going to have a reduction in a number of companies, and capital is going to get scarce. Really valuable talent is going to become more valuable. Really valuable ascendant momentum stocks are going to be harder to come by.
Now, I say this and I sound like a doomsayer but I have to say, while the biotech index, the XBI is down, you know, 40%, 50%, some of our companies are doing rounds where they are seeing 5x or 7x step-ups between those rounds because they are singular in their space, they’re doing something that nobody else can do. And so part of the message here is yes, while indexes might sell-off and broad swaths of sectors might sell-off, individual idiosyncratic companies can still be absolute rocket ships. And the key for an entrepreneur that’s looking at their stock options is how do you make sure that you get into those winning companies.
JULIE HYMAN: Well, and I guess, Josh, that, that sort of is parallel to the theme that we’re hearing from so many public investors, which is it’s a stock picker’s market, which people say all the time but which now actually seems to be true. So if you’re an investor, whether you’re a public or private investor, how do you find those opportunities that you’re talking about? What are some of the criteria that you look for that means the difference between a company that’s going to do a down round and one that’s going to be able to step up like what you’re describing?
JOSH WOLFE: Well, a lot of it comes down to industry position. You know, the talent and quality of the management team. That’s the number one thing in private markets that we’re looking for. We like people with chips on shoulders, where you’re convinced that chips on shoulders put chips in pockets, people with something to prove. And no matter what comes and what volatility and vicissitudes in markets may be thrown their way, they just will not ever stop. They just keep going. And so that’s super valuable. So that’s number one.
The second is a defensible technology position. You know, you have people that used to say oh, moats are nonsense. You know, Buffett and Munger aren’t dead and they’re not dead yet and value investing isn’t dead. And one of the great tenets is buying something for less than what it’s worth today so that it grows in value and ultimately the rest of the market sees what you see. A lot of that comes from a competitive advantage. Competitive advantage could be a locked up supply chain, it could be some technological capabilities, some set of patents, something that allows a company to do something that nobody else in the world can do.
When you look at some of our companies, Eikon, this is a private company that has a set of microscopes and instruments that allow you to see inside of cells in real-time. That has never before been possible. That’s the kind of company that when everybody else is struggling in biotech attracts $0.5 billion, $500 plus million of new financing because the demand to invest in that singular set of capabilities is there.
So as an investor, you’re really trying to find the n of one, the one company in five, in a small sector, that is going to be the absolute leader. You do not want to be invested in sectors where there are 500 competitors and no barriers to entry and just money sloshing around. It’s too messy, it’s too chaotic, it’s too much driven by luck. Find dominant technology, incredible management, big growing markets, and some competitive advantage where they can do something that nobody else in the world can do.
JULIE HYMAN: Useful advice for a lot of people. Josh, thank you for being here. Really appreciate it. Josh Wolfe is founder and managing director at Lux Capital. Thank you.
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