The most common question we’ve fielded from LPs lately is one around valuation pricing. “What are you seeing out there? How big is the delta from 2021?”
Most VCs love this question – they use it to share their anecdotal experiences with recent pricing patterns, like the AI capital chasing bonanza or the desert dry IPO markets.
But at the earliest stages, the truth is that outside of a small decline in founder expectations nothing has drastically changed in terms of price.
Why? As seed stage investors in the built environment, we are price setters, not price takers.
Price setters describe firms playing at the earliest stages, the first professional checks-in, who are making non-consensus bets where competitive VC dynamics typically don’t exist.
Price takers would be VCs participating in competitive venture dynamics, focused on funding the sure-thing seed stage and Series A+ deals in only the hottest markets.
It should follow that price setters don’t participate in broader market volatility as much as price takers do. In fact, they participate in two entirely different professions.
Price setters can be thought of as risk-seeking value investors (buy and hold) who invest only in early stage advanced technology. They are governed by the simple law that only advanced, transformative technology companies can provide the exponential returns needed in a short burst of time (to account for the high failure rate). Price setters are really only concerned about their companies moving from zero to one.
In contrast, price takers are momentum traders, meticulously studying growth rates, scrutinizing cohort analysis, modeling for macroeconomic influences (like interest rates) to properly forecast downstream funding risk and exit timing, much like a hedge fund would. Their performance moves as the broader market moves.
The interesting thing about the built environment is that 95% of deals exhibit non-competitive venture characteristics at seed. Without meaningful traction, an obvious technical breakthrough, or a team resume that sings, institutional capital sources are few and far between due to perceived market difficulty. For us, that means negotiation leverage is nearly always high and we can come in and set a fair price that works for both sides. A fair price considers IP/technology cost, market potential/risk, traction, team, founder incentives, and the ownership percentage we need to have a power-law-driven return if success occurs.
Looking back at Shadow’s 15 investments made in 2021-2022, our average price was 58% lower than the average seed deal price (according to Angellist). In other words, if a price setter is doing their job well, they’re always sensitive to price. They shouldn’t bend their investing rules as multiples expand in the public markets. If they find themselves paying too much, it’s a signal that they’ve moved outside the frontier where they should be hunting.
So, you might have read somewhere that startup valuations have cratered and revenue multiples are down. At the earliest stages, in the true non-consensus deals, the deals that look entirely unappealing but end up driving the lion share of returns, we’re so far removed from that conversation that one might think we’ve been censored.
This post was originally shared as part of our The Shadow Letter series, which is a weekly email update where we demystify venture capital in the built environment. If you'd like to sign up for the weekly email, you can do so here.