Jul 17, 2023
Edison Partners Managing Partner Chris Sugden recently sat down with Nasdaq Global Markets Reporter Jill Malandrino to discuss growth-stage equity trends, how AI factors into fintech, and the challenges tech investors face in today's market.
The following is a transcript.
Where are we now with growth-stage equity investments?
It’s cliche to say this, but ‘growth at all costs’ is over. The phrase I've kind of coined is ‘you’re sort of guilty before innocent’ in proving your business model works. Everyone was given credit, thinking, “Oh the model will work eventually. If you have good unit economics, you'll get there eventually.” But today, it’s ‘show me profit.’
To be honest, I think right now there's not a choice. It's a must to get a really strong valuation. Folks are still putting money to work, don't get me wrong. But profit is not a choice. It's a must. The gray hair proves that I’ve been around to see cycles. And the bottom line is, we've seen this movie play out over and over again. People forget the lessons of the past, but the bottom line is this is going to clean up a lot of the wrongs. The real issue I think is the unicorn class that raised growth equity but hadn't yet proven themselves.
There's a valuation reset needed and a cap table reset needed. I hate to use the word ‘pain,’ but there are a lot of questions still to come in the growth equity space from companies that hadn’t yet reached that growth, that profitability. They have big revenue numbers, lots of capital raised, big valuation, but there's going to be some pain to get the capital in.
The cost of capital right now is tough. What are some of the trends you’re seeing here?
You mentioned Silicon Valley. There's a whole capital availability that has gone away here momentarily. It's coming back now slowly. SVB has kind of gotten back in the market, others have stepped in. I think what we see right now is a challenge to put together PE deals. About a year ago, it was frozen. You couldn't price debt. You didn't know where the market was.
In the fourth quarter into the first, you start to see some, “Okay, now we know we know what the pricing is. Do we like the pricing?” So I think now what the real challenge becomes is you're anywhere from 400 to 700 basis points higher on your cost of capital if not more than that, and obviously we're facing even more rate increases.
The way it affects Edison in our space is when a PE buyer shows up, what's their hurdle to get a deal done? And is that taking a full turn on valuation or multiple turns on EBITDA? When I say valuation revenue models versus EBITDA, the bottom line is that it could cost you a turn or two, because of the loss of capital.
You and Edison are known for FinTech investments, what are your areas of focus right now?
There's a convergence going on. The payment space is starting to see some really interesting opportunities, whether it's healthcare payments, whether it's creator payments—Web 3 is sort of an old term, Creator the new term. The bottom line is, there are really interesting trends going on in creators wanting to be their own business, but they need the financial services part.
I literally spoke to a company this week that I thought was really exciting. They’re, for lack of a better word, either an arms dealer or the plumbing, depending on how you like to describe yourself. But the point is, we like those kinds of businesses: the kind of businesses that are really sticky.
You can take advantage of a really big marketplace opportunity with consumers on one end and creators on the other. But you need all the back end, you need to be FINRA certified, you need to be able to run payments through your system, etc. Think about all the opportunities out there that have come with individuals being their own business, and all the financial services that go along with running your business. RegTech is huge and that doesn’t go away. In fact, we're seeing an environment where it's even more important.
How does AI factor into FinTech and prospective investments at this point?
The nice thing about AI is that it gave us some heat: some animal spirits when we needed them. I think the market was waning from a fintech perspective. In fact, in a Squawk session episode yesterday, there was a discussion around wealth management and AI. It's the new generation of “robo advisor,” if you will.
Fintech has been around and using AI machine learning for many, many years, trying to learn from your patterns of spending, my patterns of spending; was it a credit offering, was it a product we show you because of your lifestyle change, you need a life insurance product, you need health insurance product… But I think what’s happening now is it scaled - it's really a scale issue.
Now you're seeing the models get so much smarter. I'd say the interesting thing about wealth management, about the consumer loan platforms, about the neobanks, mobile banks…all these companies were building AI machine learning into their solutions. But now you've got third parties that can contribute at a truly massive scale. So, the recommendations, the decision engines, have become that much more sophisticated. And there's the cliché: it takes away people. But I think what it really does is provide better opportunities for you as a consumer, or me as a consumer, to give them an offering that isn't just a marketing offer, but rather an offer that makes sense.
Besides access to capital, what are some of the bigger challenges for tech investors right now?
I think that the tech investor world is sitting on a ton of money. So, the opportunity for an entrepreneur raising money is: if you have a really strong business that’s really profitable, there's plenty of money being put to work.
I think the real issue is all of us trying to figure out where the valuation market goes. We tend to sell more to PE firms and strategics than look at IPOs. The IPO window is starting to open a little bit as we've seen. I think we're still in for another six months—if not nine months—of real uncertainty. But like I said, enough capital has been raised. If you're a good, strong business you're getting funding.
What we've seen from an investor perspective is people are still paying quite a bit, quite frankly. Because of that capital availability for great businesses, there really is a ‘have and have nots.’ If you're sort of on the cusp of profitability (you're not profitable yet and you've raised a lot of money) that's where the real trick comes.
From the investor perspective, those are the businesses we're all looking at going, “I need to see a little bit more. It’s going to be your insiders that fix your problem.”
On the new opportunities: if you've gotten to 20, 30, 40 million in revenue and you're profitable, you're getting multiple term sheets.
Chris, appreciate the insights as always. Thanks for joining us on Trade Talks.
