Election season is the magical time where, once every four years, you find yourself wishing you could chew your own ear off instead of listen to your friends and family talk about politics.
It is no secret that the financial markets are ridiculously volatile in anticipation of potential major policy and economic changes. When we zoom in on the private equity industry, elections for any global economic power's national government adds a layer of uncertainty around the long term impact of the sector. Which, unfortunately, makes it quite a slog on the fundraising front for startups as they struggle to get interested investors to push the "Confirm" button on the wire transfer that they have been verbally promising for months on end.
So, what gives? Should would-be startup investors (venture capitalists, family offices, angel investors, etc.) wait until after the election for more clarity on the overall macroeconomic situation? If they do decide to wait, what can startups do right now to keep the lights on and live to fight another day?
In today's article, we will dive into the historical investment trends surrounding startups during investment season. While it is true that you can never time the markets, I do believe that these companies can leverage past learnings to be more strategic with their capital raising plans.
Have the US elections historically impacted private equity performance?
According to Neuberger Berman - not really. A detailed analysis using data from private equity funds dating back to 1984 shows that the immediate performance of U.S. private equity does not significantly differ between election years and non-election years. While election years have shown slightly higher volatility in some cases, this is attributed more to economic and market events rather than the elections themselves.
Moreover, the analysis found that private equity performance tends to be stronger in the fourth quarter of the year, but this effect is not specifically linked to U.S. elections. The stronger fourth-quarter performance is observed in both election and non-election years, suggesting that other factors, such as the timing of distributions and year-end financial reporting, play a more significant role.
Okay... so what is driving investor apprehension to new capital deployment?
It is not enough to simply base investment decisions off of historical trends, as each election was surrounding rather different macroeconomic trends.
Let's compare the 2008 election year with 2016 as case studies to better understand the surrounding economic context and overall private equity performance as a result.
2008 Election Year
Obama and McCain faced off during the height of the global financial crisis, which significantly impacted all financial markets, including private equity. The collapse of Lehman Brothers in September of 2008 led to a severe liquidity crunch, a sharp decline in asset values, and a substantial reduction in private equity activity.
Given the set stage, it is unsurprising that private equity performance in 2008 was notably poor, with significant declines in valuations and high volatility. The fourth quarter of 2008 in particular saw one of the worst performances in PE due to the broader financial market collapse.
This data shows a meaningful deviation from the average performance, with a negative impact on returns due to the crisis rather than the election itself.
2016 Election Year
The 2016 election occurred in a more stable economic environment compared to 2008. The global economy was in a period of recovery following the financial crisis, and the markets were less volatile. However, the unexpected outcome of Donald Trump's victory did introduce some short-term market uncertainty.
Despite the political uncertainty, private equity performance in 2016 was relatively stable. The data indicates that the fourth quarter of 2016 saw decent performance, with some outperformance in private equity returns. Unlike 2008, the 2016 election year did not coincide with a major economic downturn, allowing private equity to perform more robustly.
Okay, so history tells us to look at the current economy and that the elections will have a negligible impact on PE performance. So, let's dig into the present day situation.
Economic Context
- Interest Rates and Inflation: The U.S. economy is grappling with elevated interest rates as the Federal Reserve continues its efforts to combat inflation. High interest rates generally increase the cost of borrowing, which can affect private equity activity by making leveraged buyouts more expensive and potentially reducing the overall number of deals.
- Market Volatility: As in previous election years, 2024 has seen market volatility, although not as severe as during crises like in 2008. This volatility is partially driven by uncertainty surrounding the election, global economic concerns, and varying corporate earnings reports.
- Deal Flow and Fundraising: Fundraising for private equity has been relatively robust, though some reports suggest a slowdown compared to the record levels seen in the early 2020s. The high valuations and strong competition for quality assets are also contributing to a more selective investment environment.
Private Equity Performance Outlook:
- Potential Impact of the Election: As seen in previous years like 2008 and 2016, the election itself may introduce short-term uncertainty, but broader economic conditions will likely play a more significant role in determining performance. If the election results in a unified government, there may be a clearer policy direction, which could reduce uncertainty and benefit private equity in the medium term. However, if the election leads to a divided government, the potential for policy gridlock could sustain higher levels of uncertainty.
Political Context:
- 2024 U.S. Presidential Election: The upcoming election is generating significant uncertainty, especially after the surprising withdrawal of President Joe Biden from the race. The Democratic party is now rallying around its new frontrunner, Kamala Harris, the current Vice President, while the Republican party remains firmly behind its nominee, Donald Trump. The candidates are expected to bring vastly different approaches to economic and regulatory policies, which could lead to substantial shifts in tax policy, regulation, and trade relations—all of which are critical for private equity investments. Harris is likely to advocate for stricter regulations, particularly in areas such as healthcare and technology, while Trump may continue his previous administration's agenda of deregulation and tax cuts. The outcome of this election will have significant implications for private equity strategies as firms navigate the potential policy changes.
What are the key policies that Venture Capitalists are paying attention to?
Let's say you are a startup that has been going through the diligence process of an interested VC firm. They then tell you that "they are holding off until after election season". Yes, it is a lame excuse and your financing round shouldn't suffer. With that being said, here is a cheat sheet that you can use to understand how they might be thinking about the 2024 elections:
My startup can't wait until after the election for a financing round! What should I do?
This is the number one question that I have been receiving from startups for the past few months. And it is a fair one, as many startups will be out of business if they can't raise a fresh round of financing by November.
While this advice is not applicable to every company/sector right now and it is advisable that you consult with experts before mapping out your financing strategy, here are a few suggestions that might help you survive the storm:
Consider doing a Bridge Round of financing instead of a Primary Round
I've spoken to hundreds of startups this year, and tons of them are somewhat embarrassed to do a bridge round... and I really don't think that they should be. In fact, as I look at the hundreds of companies that have applied for funding through Intelligence Ventures, I can see that just under 10% of them are doing some sort of bridge financing round, which is actually quite high compared to what that number might have looked like a few years ago when the VC world was much more booming.
My personal observation has been that venture capital firms have not been too quick to deploy capital due to a lack of funding from their investors (aka Limited Partners). I explained why this is the case in my previous article. With the limited capital that they have to work with, they are often inclined to double down on their existing bets instead of investing in new startups. They will then come up with hundreds of reasons why they don't want to invest in your startup as a result, unfairly bruising the egos of startup founders. Other institutional investors such as family offices have been taking a look at recent private equity performance, and when tied in with the uncertainty of an upcoming election, they have been passing up on promising startups.
So why do a bridge round of financing? Well, my other personal observation has been that angel investors are still deploying capital at fair terms for the startup. While these guys are writing rather small checks ($25-250k), it is enough for a small bridge round to help your startup survive until the new year.
Let's say that your startup wants to raise a $5M Series A. Well, now may not be the best time for you to do so, for all of the reasons mentioned above. However, you are now burning through your capital and are wondering how you are going to pay your employees. You could instead consider doing a Seed extension round of $1.5M from angel investors and live to fight another day.
Build a robust investor communications strategy and stay relevant
If you haven't built an investor meeting tracker, you need to. Create a spreadsheet or CRM that tracks every single investor that you have engaged with, along with notes/status of that investor. From there, use that list to frequently communicate with them and to stay on their radar. Monthly/quarterly investor update emails are a fantastic way to stay at the forefront of the investors' minds.
There are also unbelievably stupid ways to stay relevant. For example, see below for a mindless post that I put out recently. The end result? Quite a few people that I hadn't spoken to in some time reached out to me via text/email/LinkedIn to catch up and to move business forward.
Make it clear that you have contingency plans for their concerns and show the ability to swiftly pivot
As you can see from this article, investors are consistently thinking about every single factor that can impact their investments. Whether it be a new capital gains tax or a new policy on immigrations that could affect your workforce, be sure to play a game of devil's advocate with yourself to prepare for these conversations. I cannot think of any unicorns that made it big by implementing the exact strategy that they had on day one. Pivoting is good. Being stubborn isn't.
Don't lose hope. You've got this.
Originally published on LinkedIn