March 2021

Over the last few years, SPAC activity has exploded from just 19% of all public offerings in 2018 to 53% in 2020 and 77% thus far in 2021. Much of this SPAC activity is being driven by private equity firms, growth stage venture funds, and high growth emerging technology businesses looking for an off-ramp while the market will still tolerate and pay a premium on assets that may already be priced a touch high. That’s not to say that all companies going public via SPAC are overpriced; however, unlike the traditional IPO route, SPACs come with less price sensitivity and scrutiny, and also less risk that the asset ends up trading at a price lower than the last private round – a common occurrence in the public markets as of lately.

To meet this growing supply of companies interested in the SPAC route are more than 370 U.S.-based blank check companies with over $118 billion in capital actively seeking acquisition targets. While U.S.-based businesses are seeing the bulk of interest from American SPAC issuers, Israeli start-ups are also being courted heavily given the technical moat that surrounds many of the country’s top emerging technology companies. Start-ups like Otonomo (automotive data), Payoneer (fintech), Innoviz (automotive Lidar), Taboola (ad platform), and Fundbox (fintech) are all Israel founded companies that are planning a 2021 public listing via SPAC. And more are sure to follow.

A direct byproduct of this SPAC proliferation is a spike in valuations across the start-up ecosystem. This can be seen most clearly in looking at the number of companies in the last 12 months or so that have raised capital at $1B+ valuations thus achieving ‘unicorn’ status. Out of the nearly 600 unicorns globally, 40% were created in just the last year – 15% in 2021 alone. In Israel in 2018, there were just 18 unicorns. Today there are 45 – 33% of which achieved unicorn status in 2020. While some of these unicorns are deserving of their valuations, we believe that the current market conditions are contributing significantly to some unsustainable pricing – that is a price per share with no relationship to a company’s revenue or EBITDA. Also contributing to some of this inflated pricing in the SPAC market are the venture funds that have had to invest larger dollar amounts at higher valuations to incentivize entrepreneurs to keep their businesses private longer. This has trickled down to even earlier stage investors who are willing to ‘pay up’ for assets to win hyper competitive deals knowing that upstream investors are understanding of and willing to continue paying a premium for those assets.

In our view, this flood of SPACs and the corresponding pricing is indicative of a market heading towards a correction that may reset some of the values associated with these high-profile, yet money losing ventures. While we at Janvest are taking note of the consequences and opportunities of this SPAC frenzy, we believe the best course of action is to remain disciplined in our investing and operations. Here are a few ways we are doing so:

Risk Mitigation through Valuation Discipline
One of the quickest and easiest ways to add unnecessary risk to a venture is through early round pricing. In other words, when an investor places too aspirational of a valuation on a business too early (or too late) in its lifecycle, it leaves little margin for error for that company to grow into that valuation in preparation for the next round or liquidity event. More and more companies are falling into this pricing trap -- over the last five years, the average round size in Israel has jumped exponentially from around $7M in Q4 2015 to nearly $18M by Q4 2020. Even seed rounds, with the exception of H1 2020, are increasing in size by 10 to 20% year over year. This spike in round size has been accompanied by a spike in valuation, which some entrepreneurs see as THE leading indicator that they are going to be successful. This is most certainly not the case and in fact is, in our opinion, THE leading factor contributing to a sub-optimal outcome or exit by forcing a valuation on a business that it doesn’t deserve and which acquirers will not pay unless there are corresponding metrics.

We at Janvest, and our entrepreneurs as well, look at things a bit differently. For us as a fund, we have grown to accommodate the natural increase in round sizes and valuations; however, we optimize around the value we can bring, not the price we can offer when it comes to competing for investment opportunities. We are also of the belief that if you start off with too much capital in the bank, that can lend itself to a ‘money spending problem’ which is at epidemic proportions in the start-up world and is the antithesis of ‘running lean’ and remaining capital efficient - something we value greatly. In addition, by remaining modest in the round sizes we lead and the valuations we place on our businesses, we offer them maximum flexibility for their next few rounds, as well as any interim rounds that might be needed.

For our entrepreneurs, we have instilled in them the belief that a) round sizes and valuations should be based on accomplishments achieved, and b) optimizing around valuation too early increases the chances of a disappointing set of rounds later down the round when the stakes are dramatically higher. A reasonable and appropriate valuation early means that founders don’t have the unnecessary risk of having to grow into an inflated valuation, which in many cases means optimizing for short-term revenue over long-term product-market fit.

In the end, this strategy has and will continue to contribute to a portfolio full of healthy cap tables that are well positioned for successful future raises and exit optionality.

Round Sizing for Future Success
The aforementioned ‘money spending problem’ is often triggered early in a start-up’s lifecycle when founders raise an unnecessarily large amount of money, which of course comes with an unnecessarily high valuation. This type of spending will result in 2-4 additional rounds of financing (and dilution) over the lifecycle of a business and forces founders to always be in capital raising mode rather than having the dedicated time to focus on product and growth. Economic return is not simply a function of ‘buying low and selling high’. It is critical to also take into account that more funding rounds and dilutive events can have an even more destructive role than buying in at too high a valuation.

In our view, at the seed stage, a company should have enough capital for 18-24 months of operations before having to raise their next round. This means that founders are comfortable enough to run their business quietly for a year or so, but not too comfortable that they don’t have to be aggressive in pursuing product-market fit and commercialization. A $2.5-$5M seed round is ideal for an Israeli start-up and it also leaves a lot of optionality for that next round whether it be a proper Series A or a Seed II round of financing, which has very much become commonplace. By starting out grounded in round sizing, we at Janvest are setting our portfolio companies up to be more strategic and thoughtful in their raises – attracting the appropriate amount of capital to effectively execute on their next set of objectives at a valuation that is representative of growth but which does not add unnecessary risk to the business such as being priced out of an M&A or being forced prematurely into a SPAC to ensure investors can get their money out.

Exit Optionality
We believe that being pragmatic when it comes to creating liquidity from an asset is the best way to align entrepreneur and investor interests. Not every start-up is meant to have a multi-hundred million or billion dollar exit. However, as venture funds have gotten bigger, their ability to be opportunistic on exits has diminished. So, while a founding team may see a great chance to sell early, some of their backers have too much AUM to allow that to happen. This creates a scenario where you have unmotivated founders being pushed aggressively by investors to produce an outcome that has more of an impact on their oversized funds. This investor-entrepreneur misalignment can, and does in many cases, have disastrous consequences. We take a more pragmatic approach when it comes to exit opportunities which we see as critical long term alignment with our entrepreneurs.

One of the things we appreciate most about seed stage investing is the optionality it presents when it comes to creating liquidity. Through valuation discipline and appropriate round sizing, we at Janvest have set ourselves up to take advantage of an array of transactions that could produce a successful outcome for our investors. This includes smaller price point, as well as larger price point M&As, secondary buy-outs at late stage growth rounds, and, most relevant to this article, SPACs and IPOs. In 2019 we took advantage of a smaller price point M&A and returned 40% of an early fund. In 2020 we took advantage of a secondary transaction and did a multiple on some funds while heavily de-risking most of the others. And in 2021 we could potentially monetize on a SPAC surrounding WeWork – shares we acquired through the company’s 2017 acquisition of Janvest portfolio company Unomy. For the record, if WeWork does go public via SPAC, it is our intent to monetize at the earliest possible opportunity.

By remaining disciplined in our investment activity – deploying when we should, not because we are forced to – and at valuations that leave room for growth, not tops them out prematurely – we can avoid much of the risk of this SPAC activity regardless of which direction it goes in the coming years.