By Hal Callais
A Look Back at Covid
Last year, I wrote a blog that covered a handful of business forecasts about where we would be post-COVID. Going into the holiday season, many macroeconomic concerns, inflation woes, and hiring/labor force issues continue to persist. At Callais, it felt like a great time to revisit my earlier post, elaborate on what has changed, and offer guidance to entrepreneurs navigating this unheard of venture market.
Just to summarize my prior article’s main points:
- You can’t issue unlimited quantities of debt without a blowback
- Increased levels of debt require breakaway growth
- VCs are taking more risk with “dry powder” cash reserves
- Deals are closing quicker, creating FOMO and increasing potential loss rates
- Larger opportunities for startups to raise PE growth capital, or be bought due to these conditions
My key concerns in looking forward boil down to inflation, asset pricing, and PE/VC dealmaking.
Inflation
Big macro things like inflation are the best summary tools for how the markets are behaving and what startups are trying to grow into. Inflation is being felt in our daily lives when we go to the grocery store, tank up at the gas station, or generally spend money on anything. Isolated inflation in the US makes foreign goods more expensive. In response, imported goods become more expensive for the consumer. Plain and simple, the Fed’s purchase of debt added cash to the money supply, requiring real economic growth to keep inflation at bay.
As of today, we’re seeing soaring energy prices, wage price hikes, poor delivery times, and a de-globalization of the supply chain. Although this is creating an “upper hand against employers,” those higher costs tend to get passed down to consumers in various ways. Which can, in turn, become a net loss of purchasing power despite the wage gains.
With Q3 earnings underway, pay attention to the way that businesses handle their higher employment costs, supply/worker shortages, and rising prices. Supply chain hang ups have been lasting longer than expected with transportation port delays and truck driver shortages. As a result, there is a potential rise in moving supply chains closer to home, “de-globalizing” our reliance on imports and particular supplies that are unattainable. Even Amazon’s ginormous deflation machine is feeling it.
Returning to 1970s inflation is unlikely, but it could feel that way with the 2010 changes to CPI calculations. Although it won’t register like that, an inflation scare could worsen the problem and become a self-fulfilling prophecy if businesses and workers assume a greater inflation rate for 2022. Higher earnings for employees could mean higher prices for products. Treasury Secretary Janet Yellen has calmed the waters by stating that increased prices will ease once supply chain issues are resolved and pandemic recedes. To reference an example, the global chip shortage has directly impacted the production of more than 1 million vehicles just in North America.
The latest data from the U.S. Bureau of Labor Statistics (BLS) shows that inflation in the US is slowing down. But the report also mentions indicators regarding a challenging road ahead with our recovery. Personally, I am seeing a lot of big banks estimate that inflation will temporarily increase before coming down. But I think that there is a good chance that legislation will make a material impact to this. If you add subsidies and labor to the mix, issues can be exacerbated as the low-skilled labor will have trouble justifying going to work until wages increase. And although skilled labor is in demand, a wage increase might also be necessary to incentivize them to return to their work hours.
Asset Pricing
Asset pricing is driven by the higher end of the wage gap. With an uneven balance in C-suite salaries, (ex., CEO pay skyrocketing 1,322% since 1987) retirement and investments accounts can be hit.
Another asset price that is also on the rise is labor assets. Simply put, how much your workforce is costing you. Professor Anthony Klotz of Texas A&M University anticipated a wave of resignations across the United States as a result of the process of rethinking the present and future of work. Many companies are struggling to address the issue as they’re forced to come up with creative solutions. Donaldson Company adjusted its corporate supply chain team—even calling back recent retirees—to help smaller suppliers with scheduling and logistics. With wage growth on the horizon, and skilled labor in highg demand, it’s a good time to ask for that raise.
PE/VC Dealmaking
In a prior article, we discussed raising traditional VC money during a global pandemic. The private equity sector has a lot of dry powder to invest in potentially more risky investments. In turn, startups might be able to leverage that to achieve a higher price point for their current fundraising initiatives. Selling businesses is definitely appealing to some.
But more deals means more competition. It is no longer enough to simply write a check to a business you are investing in. You need to invest your resources to offer value-adds to set yourselves apart.
This has led to a fervor of deal activity across the risk spectrum as funds holding lots of cash are taking greater than expected risk and paying more than they otherwise would from competition. Not to mention that there has been an explosion in the number of SPAC’s in the market seeking targets, often competitive with the buyout funds. What we are seeing, is a rush of too much capital chasing after too few deals.
In venture capital, we are seeing many funds reaching beyond what they would have otherwise done and closing deals in days instead of months. This speed should be a big concern for their investors as speed to win deals, based on FOMO, can increase a funds loss rates. This is especially true when it comes to younger funds with 2018 and 2019 vintages. Unicorns, IPOs, and exits are at all-time highs, which puts more capital into the system and forces dealmaking across the spectrum. In the first half of 2021, we saw 250 unicorns amounting to $288b+ invested.
However this activity is occurring, there is an opportunity for startups to raise growth capital, or be acquired due to these heightened conditions. But if we’re not careful and the shoe drops, this could end up as a transfer of risk from VC to PE.
Startup Pulse
The pandemic has sparked a “tidal wave of entrepreneurial activity.” 4.3 million businesses filed corporate filings last year. That’s coming off of a 40-year startup creation slump. Millions of Americans have since started companies out of need—and/or opportunity. Forbes noted that “the most significant spikes in these job-creating businesses are happening far from expensive coastal hubs. Instead, the deep South is driving the boom, with triple-digit growth across Georgia, Mississippi, Alabama and Louisiana.” That’s good new for the Gulf Coast region Callais Capital is in.
- Tidal wave of deal flow. 4.3M businesses new business filings.
- Built Covid tough. With the pandemic, companies are learning how to flourish with restrictions.
- COVID-safe environment and remote workforces.
Never has it been more acceptable to start a double-bottom-line business. ESG startups (Environmental, Social, and Governance) are on the upswing and a new generation of entrepreneurs are emerging to tackle the future of our world. As an investor, that’s an exciting chance to support companies and initiatives that we believe in. Resilia is one that comes to mind for me, which was an investment Callais Capital deployed in Fund II.
We are personally seeing more and more startups defining themselves as Public Benefit Corporations (PBCs), which are corporate entities that present a social benefit to the greater good. It’s baked into their mission statement and can even influence board decisions since profits come second to their stance. Not only does this impact future industries, but it addresses the type of entrepreneurs that are emerging to tackle the problems of tomorrow. Out of the ashes of calamity always rises inspiring entrepreneurs like Something Borrowed—and our newest company Brewsy. Entrepreneurs will always find a way to create the future. But as a VC, we need to constantly adjust our lenses to see them clearly. It’s an exciting time for founders and financers.
In this startup boom, venture capitalists like Callais Capital need to be aware of the rise in deal flow and create a successful process in vetting the rise in leads.
Are you a startup founder in the Gulf Coast? It’s never too early to reach out, even if it’s not the right time. We know that companies take time to turn a profit and find their product market fit. We would love to hear what you are working on.