Fri. Jan 21st, 2022

What could go wrong?

Kick-off 2022 It might feel like we’re stuck in the third round of 2020, but things have actually changed quite a bit in Technology Land, even if the pandemic is still with us.

Crypto has become much more established in the intervening period, for example with more investors, startups and fundraising in the space. Another change from the pre-pandemic days is the value of software revenues.

That may sound a bit esoteric, but since much of the startup world builds and sells software, the value of that revenue is incredibly important. As the value of software revenues rises, so does the value of software startups. That lowers the investment risk. In turn, the climate to invest in software startups — that is most of them, mind – gets warmer as risk decreases.

I won’t bore you with the mechanics of changing startup risk in a market full of rising revenue multiples. What matters today for our purposes is to note that software has become more valuable since the start of the pandemic, causing investors to be the norm more often than before, arguing over startup deals and anticipating private rounds.

The result? Rising startup prices.

That startups have become more expensive, measured by comparing their valuations to their earnings, is reasonable. However, software valuation growth in H2 2020 slowed last year as SaaS and cloud stocks closed 2021 a fraction lower than where they started the year.

In fact, 2022 is off to a downright nasty start for software stocks. The Bessemer Cloud Index (trackable as the $WCLD ETF), a basket of public software stocks, has lost a lot of ground so far in 2022 (the following chart has a range of five days, so watch the dates):

Image Credits: YCharts

The index falls around 5.8% Today as I write to you.

Zoom out how the same basket of software and cloud stocks has lost ground since early 2021:

Image Credits: YCharts

Now this would normally not be a problem. Stocks go up and stocks go down. That’s what they do best.

But there are second-order effects that must be taken into account. As the value of software stocks rises, startups that benchmark their current and future value have rich compositions to take advantage of. As those same software stocks lose ground, the startup compositions begin to make less sense. So the relationship between the prices of listed companies and the value of startups.

As software stocks rose in 2020, the willingness of tech investors to pay more for less startup income increased. And it seemed to continue to climb last year, even as software stocks struggled to hold onto their 2020 gains. But from a late peak in 2021, those same stocks have returned all of their recent gains, and more.

In particular, this rather sharp fall in value does not seem to affect retail markets in the same way:

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