US gross domestic product has experienced two consecutive quarters of negative growth. The economic downturn is largely driven by the Federal Reserve’s decision to increase interest rates in June and July by three-quarters of a percentage point. This policy is designed to temper overwhelming post-pandemic inflation. The second half of this year also looks dim, as the Federal Reserve is planning another interest rate hike in September.

As a result, the public market indexes have sunk. As I write, the Dow Jones, Nasdaq, and S&P 500 are down by 15%, 27%, and 19% year to date, respectively. And many blue chip, large cap companies — companies that are known for stability and profitability — have underperformed the market. Netflix saw its stock drop 63% year to date. Pharmaceutical giant Moderna had a 44% decrease during the same period. Many investors are now losing confidence in the public market due to its stagnant performance. 

The public market is also dragging the private market down. According to KingsCrowd’s database, the total valuation of the online private market dropped 40% from April to May 2022 alone. Series A and Series B tech company valuations fell by 14% and 16% respectively in the second quarter. 

So at first glance, investors might worry that it’s a bad time to jump into the market. However, there are huge opportunities hidden behind this turmoil. 

Lower Valuations Can Turn Into Greater Returns 

To achieve a higher expected return, investors need to identify undervalued companies — a strategy practiced by many value investors, including Warren Buffett. When the market is doing well and companies are marking up their valuations, this strategy is challenging. 

However, during a market downturn, companies lower their asking prices when they raise money. For example, the current median software company revenue multiple is 30% lower than the long-term pre-pandemic average. This means investors can now pay less for every dollar of revenue a company generates. When the company exits, investors are likely to sell the company for more than what they previously paid. Furthermore, a larger gap between the buying price and selling price will result in a larger return. In this way, lower revenue multiples can reduce investors’ risk and increase their expected returns. Investors have more opportunities to follow the golden rule of “buy low, sell high.”

More Deals and More Power to Investors 

According to the KingsCrowd database, new deals in the online private market surged by close to 10% in the first half of 2022. At the same time, the total amount raised in the online private market has steadily declined (shown in the chart below). So though there are more deals available, investors are pulling back. 

Active investors can take advantage of this situation. Retail investors have more deals to choose from and can worry less about deals getting fully subscribed right away. This benefit, combined with lower valuations, can substantially boost the returns of their portfolios. Institutional investors now have greater bargaining power since the supply (investors) is currently less than the demand (companies). Institutional investors can thus negotiate more favorable investment terms and get more shares in companies. 

In sum, both retail and institutional investors now have less competition, and their dollars are now more valuable during market downturn. Private market investors who have a significant cash reserve should capitalize on that.   

The Private Market Outperforms the Public Market 

The private market historically outperforms the public market following a recession. That’s because during a market downturn, companies in the private market tend to be more flexible than those in the public market.

Private companies have smaller teams than public companies. So it’s easier for private companies to reorganize their teams during times of crisis. 

Many private companies are also still at early stages. So it’s easier for them to observe and pivot their go-to-market strategies during and after the market downturn. In contrast, established public companies often lose existing customers when they choose to pivot. 

Lastly, private companies have simpler decision making processes and can be quicker to react. During times of crisis, efficient decision making often makes or breaks a company. Public company CEOs often have to make decisions based on the opinions of senior executives, board members, shareholders, and customers. It’s difficult and often takes a long time to align the interests of all the different stakeholders. 

For those reasons, private companies are more likely to bounce back and outperform public companies following a market downturn. And a stable company makes a less risky investment.  

Opportunities in Debt and Revenue Share Deals 

Besides equity investing in the online private market, debt deals (in which investors lend money with interest) and revenue-sharing deals (in which stakeholders receive part of the revenue) can also be good options to diversify and de-risk a portfolio. Debt and revenue share deal returns can come a lot sooner compared to equity deal returns. Investors can collect debt and revenue share payments quarterly and even monthly rather than waiting until a company exits — which can take years. 

KingsCrowd actively tracks quality debt and revenue share deals across online platforms, such as Mainvest and Honeycomb. Both accredited and non-accredited investors can stay updated on these deals.

A Long-Term Strategy

A typical recession lasts about 17 months. A venture fund like KingsCrowd Capital Fund I has a 10-year fund term. There could be several market cycles during the fund’s lifetime. KingsCrowd Capital can capture these market downturn opportunities by deploying capital at the right time, having a long-term strategy, and not shying away from the temporary market correction. 

To learn more about KingsCrowd Capital’s first fund and to invest, please visit the fund website or email for more information.