Annual Investor Letter 2022
Friday, December 23, 2022
To the Founders, Investors and Partners of Allied VC,
Despite the changing economic tides over the past 12 months, I thank you for another great year of support and enthusiasm as we continued scaling Allied Venture Partners.
As you'll recall, Allied is the amalgamation of the best practices I've learnt over the past 9-years as an angel and scout, so it's wildly exciting to see it exist in the world and for such a sustained positive response among founders and investors.
I know you're very busy, so I'll do my best to keep this brief. In line with my investor letter from 2021, there are three key topics I'd like to cover in this update:
Syndicate Metrics, Outlook & Portfolio Construction
The Current State of Markets (Public & Private)
Looking Forward: Phase Two, Phase Three
1) Syndicate Metrics, Outlook & Portfolio Construction
Allied Venture Partners has grown to 1,500+ members globally, with investors from more than two-dozen countries. Moreover, our Scout and Advisory programs continue to be a great success, establishing a dealflow flywheel that is increasingly robust and global.
I often say that running Allied is like having a team of hundreds of talented individuals lending their expertise, so Thank You to all who have referred companies and helped throughout our diligence process. Allied would not exist without you.
Regarding our 2022 investment progress, Allied helped raise just over $1M USD, making nine investments across nine companies. Five of these investments were first-time investments, and four were follow-on investments. These investments were part of an overall $28.35M in total funds raised by our founders. These companies include:
In line with our investment mandate, these nine investments include one at Pre-Seed, five at Seed (including one follow-on Seed investment) and three follow-on investments at Series A.
Furthermore, our thesis of co-investing alongside top-tier investors is executing well. This year we co-invested alongside notable firms such as Slow Ventures, Gaingels, Draft Kings, Techstars, Launch Fund (Jason Calacanis), TEN13, Animoca Brands, Plug and Play, DNX Ventures, Hustle Fund, Garage Capital, Visa, Panache Ventures, AngelList, and Grammy Award-winning artist Pharrell Williams.
Among our four follow-on investments, we were fortunate to participate in several significant markups from our initial entry point, including a 6.25x, 5x and 2.1x. We also had one acquisition.
To reiterate our investment mandate, my goal is to operate Allied with the diligence and discipline of a top-tier VC fund yet with the flexibility of a syndicate. As such, I feel our disciplined, thesis-driven approach (i.e. mindful of entry price, ownership, capital efficiency and deal economics) is holding up well against current market volatility.
With that said, it's still early days, and our founders will have to navigate challenging waters over the ensuing 12 months. As such, we might see flat (or potentially down) rounds, which may not be reflected in our current marks.
In terms of pacing, adding five new portfolio companies is in line with my forecast of 4-6 new companies per year. This pace aligns well with our process time of 3-6 weeks while remaining mindful of vintage diversification. The Allied portfolio now comprises 13 companies as we work towards my target of 25-30 companies over a deployment cycle of 3-4 years.
Recall from our investment thesis that my goal is to construct a slightly more concentrated (yet higher quality) portfolio. I want the capacity to support our founders when required, so scaling Allied in sync with new portfolio additions is critical to avoid spreading ourselves too thin.
In 2023, we will remain consistent with our approach of finding unique opportunities that others have overlooked, and then double down as they break out. We currently have several exciting opportunities on deck that I look forward to sharing with you in 2023.
2) The Current State of Markets (Public & Private)
My July 2021 blog post continues to age well. However, Russia's invasion of Ukraine was undoubtedly a catastrophic and unexpected black swan event.
We had been struggling to control inflation since Q4 2020, yet the war's escalating impact on energy prices poured fuel on the fire, pushing inflation beyond my anticipated range of 5%-7%. In June, we saw inflation peak at 8.1% in Canada and 9.1% in the US.
As we know, central banks around the globe responded with ongoing interest rate hikes to curb inflation, which appear to be working, following five consecutive months of declining inflation through November 2022.
Unfortunately, these interest rate hikes dramatically affected technology companies, suppressing valuations and causing a ripple effect throughout the entire funding chain, which we are now experiencing at Seed and Series A.
As a result, institutional LPs, who watched much of their 2021 public market gains evaporate in June (and again in October), now appear overweight private equity and VC (aka the 'denominator effect'). Since private companies are not marked daily like their public counterparts, it takes longer for those private positions to get repriced and be accurately reflected within portfolios.
For this reason, we've experienced a slowdown among late-stage pre-IPO financings, all the way down to Seed, as LPs await the repricing of private positions. Consequently, we're seeing General Partners struggle to raise new funds, which impacts Founders attempting to complete new financings. We witnessed a similar standstill in 2001 and again in 2008.
Thankfully, there is a silver lining, and I believe we are now in the seventh inning of this macro down cycle, with the final shoe set to drop next year as real estate prices bottom out. As we've seen, public markets have begun to price in a recovery (albeit fragile), as evidenced by the rally we've experienced since October’s lows.
Furthermore, although the US economy sustained a very mild & shallow recession earlier this year following negative GDP prints in Q1 and Q2, this trend has since reversed, following robust consumer spending in Q3 combined with the strongest labor market in forty years.
In Canada, we’ve managed to stave off a recession thanks to a resilient employment market, robust consumer spending, and healthy corporate earnings from our oil & gas sector. Nevertheless, higher interest rates will catch up to the labor market, and economic growth is expected to slow in 2023. If we do experience a recession, I anticipate it will be mild and short-lived, likely in the second half of 2023.
Lastly, we've heard increasingly dovish sentiment from central banks in recent weeks, which appear to be slowing the velocity of interest rate hikes. At the current pace, I anticipate we'll see another 50-75 basis points in Canada (ending the cycle at roughly 4.5%) and another 50-75bps in the US, placing us at approximately 5%. I anticipate these rate increases will occur in Q1 2023, with central banks hitting the pause button by Q2.
Where does this leave us in private markets and early-stage venture?
As inflation and interest rates normalize and stock markets continue their recovery, we will see a return of risk capital into PE and VC (albeit slowly).
As I described in my 2021 letter, record amounts of VC funding resulted in too much capital chasing too few opportunities. As such, we saw many startups take on incredible valuation increases without the supporting KPIs, forcing the arduous task of growing into said valuations to achieve the next funding milestone.
Since the cash bubble burst, we've seen a flood of down rounds, layoffs and outright shutdowns over the past eight months. Sentiment has done a complete 180° from growth and free money to discipline and capital efficiency.
As with any market, the pendulum always swings back to the other side, and a reversion to the mean ensues. In the past several months, the quality of our dealflow at Allied has improved dramatically, as companies that raised in 2021 without a clear vision or business model are getting weeded out.
The teams solving real problems for real customers, generating actual revenue, and who've managed to maintain discipline regarding burn and unit economics are rising to the top. Capital is not frozen; it's simply more selective in where it chooses to reside.
For those with a long-term horizon and willing to look beyond near-term volatility over the next 12 months, early-stage venture is currently one of the most exciting and opportunistic markets.
For instance, growth-stage VC (which operates more like private equity) has gotten crushed in line with public markets (i.e. Series B to pre-IPO). Early-stage venture, however, has a unique advantage in that it benefits from reduced volatility via infrequent valuation marks, since companies are typically repriced every 12-24 months (as they achieve milestones and complete subsequent financings).
Meanwhile, the volatility and falling valuations at the growth stage have suppressed valuations all the way down the chain, making for some incredibly attractive opportunities at Pre-seed to Series A.
As early-stage venture investors, this current setup, whereby we benefit from reduced volatility combined with lower valuations, is something we might only see once per decade, and it's where generational wealth is created.
I believe the seeds are currently being planted for the next cohort of unicorns set to emerge by the latter half of this decade, so don't get caught on the sidelines.
3) Looking Forward: Phase Two, Phase Three
I launched Allied to expand the pool of available capital for Western Canada's startup ecosystem while concurrently providing local investors with increased access to high-growth opportunities from established VC markets.
To achieve these goals, Phase One required building a global investor network by syndicating attractive venture-scale opportunities from established VC markets. This was my primary focus for 2021, and I'm pleased to share that Phase One is complete. Allied comprises 1,500+ members from more than two-dozen countries, and we continue to add new investors each week.
Throughout 2022, as the syndicate reached certain milestones, I began executing Phase Two: introducing more Canadian (and potentially overseas) investment opportunities into the Allied portfolio. I'm pleased to share that Phase Two is well underway – we added our first Canadian investment earlier this year, as well as an investment from Australia.
I maintain that approximately 10% to 20% of our investments will be Canadian-based. It's simply a numbers game, and with a population ~10x larger, we see far more opportunities from the US market. Nevertheless, I look forward to adding 1-2 Canadian companies to the portfolio in 2023.
Regarding Phase Three, I am still considering a pre-seed fund enabling early checks (i.e. $25k to $50k) into talented teams where we have high conviction, supported by larger follow-on investments from the syndicate as they break out into Seed and Series A.
I maintain our principle of working with founders to build our ownership position over time, targeting 50 to 500 basis points per investment and ultimately reaching 10%+ ownership (pre-dilution) within our best-performing companies. A small pre-seed fund would help us achieve this goal by enabling 1) earlier entry, resulting in 2) the opportunity to build a larger ownership position over time, and ultimately 3) increased optionality for earlier liquidity through a proactive secondaries strategy, yet still maintaining the majority of our positions for long-term capital appreciation.
As for timing, given the current macro fundraising environment, I have pushed Phase Three into H2’23 and will reevaluate as market conditions evolve. In the meantime, we will continue supporting founders through our current SPV structure, which, given current valuations, provides us with ample opportunity to build meaningful ownership positions within attractive early-stage companies.
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Thank you again, Founders, Investors and Partners, for your continued trust and support throughout a volatile 2022. As always, connect with me on LinkedIn, Twitter or by email. I'm always happy to chat about startups, fundraising and everything in between.
Lastly, on a personal note, my wife and I are safely back in Canada following her 1-year work contract in Australia.
Building Allied remotely from Sydney for the first year involved many late-night and early-morning Zoom calls, so I'm happy to be back in a North American time zone. Nevertheless, it validated the ability to scale Allied remotely, and I'm incredibly grateful for the friends and extended network I formed while in Australia. My wife and I are excited to revisit in 2023, and I look forward to more great deals with my friends down under.
2023 here we come!
Best,
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Matt Wilson, MBA
Founder & Managing Director | Allied Venture Partners