Activant's Greene Street Observer No.14

Founders, Partners, and Friends,

The last couple of years have been tough, and the next couple of years should be no different for the private technology markets. As an observer of the private markets for years, it tends to overshoot on the upside when things are good and the pendulum can swing the other way on the downside as well - which is what we are seeing now. It is easy to have conviction that things have overshot because one can see it in the aggregate private market distributions to LPs. Distributions have been anemic and will likely continue for the next few years.

Both M&A and IPOs have been slow and there aren’t many reasons to see a quick pick-up. Four primary forces are slowing the pace of strategic M&A:

1) High interest rates create a higher bar to deploy both cash and equity. 

2) Many companies were created in the 2020-2021 run provide ample target opportunities, so a wait-and-see approach is reasonable for any large corporation. It is difficult for any business development or corporate M&A group to zero in on the exact right thing in this market.

3) New technology tends to muddy the water when thinking about an M&A strategy - AI is no different than the internet in the 90s. Once things settle, M&A picks up but tends to be slow in the early days of a cycle.

4) Lastly, the FTC has put a gigantic damper on strategic M&A. It has become a massive roadblock for liquidity and should not be underestimated.  

What about the IPO window? I never liked the window analogy as it sounds like you can defenestrate any company regardless of performance. I think the concept of the window will be dead perhaps until the end of this decade. Instead, the window will always be cracked, but with the screen down, so only the best of the best will get public and it will likely happen as a slow trickle over the next few years. The all-or-nothing IPO concept has been defenestrated as well. Lack of IPOs also affects strategic M&A and you can start to see the compounding effects of this market - although there is a light at the end of the tunnel. 

What should worry everyone more is that a dozen or more behemoth companies are driving almost everything and anything in tech: Microsoft, Alphabet, Meta, etc. They have a massive regulatory and capital advantage, and with the right focus, can move into any area of AI or otherwise to build their business. 

I hear pundits say things like “Never before has so much wealth been concentrated in so few companies” - and the power is astounding. It transcends governments and borders. However, like most things, we have seen this before in history. 

These large technology companies have replaced, in more recent times, the JP Morgan’s of yesteryear. When there was a gold standard, governments needed to work with the banks to conduct war and imperial expansion - this is no longer the case with fiat money. The gold standard effectively acted as a governor. In fact, our founding fathers were weary of this and lavishly expended ink arguing the merits of a backed currency. Even George Washington wrote to Thomas Jefferson, “Paper money has had the effect in your state that it will ever have, to ruin commerce, oppress the honest, and open the door to every species of fraud and injustice.” 

The new governor is technology served up by the major tech companies. The large technology companies wield tremendous power over not just individuals, but the state. Abraham Lincoln warned of this when he wrote, “Corporations have been enthroned and an era of corruption in high places will follow, and the money power of the country will endeavor to prolong its reign by working upon the prejudices of the people until all wealth is aggregated in a few hands and the Republic is destroyed.”

In the past, there were many examples of when corporations were powerful. When we look at the wealth creation of the British Empire, which took off in the 1600s, it magically coincided with the creation of the East India Company. At its peak, the East India Company was more valuable than Amazon, Microsoft, and Meta combined (inflation adjusted). It had an army larger than that of the entire UK, and it drove incredible wealth for the empire. Will the large companies of today do the same? Can you imagine a large corporation with an army? It happened and we may see it again in the form of private security or embedded in AI.

If large corporates drive more power for a government, why not protect them like the British did the East India Company (at least for 150 years)? It is unclear how the dance between large companies and governments will play out, but the easy assumption in the short run is more regulation that acts like a moat to protect them and making it harder for start-ups. This is the third compounding effect (M&A, IPO and regulatory) making private markets difficult. Bill Gurley gave a great talk on regulatory capture, which you can find on YouTube.

Two countervailing forces that should propel the private markets towards the end of this decade are AI and the corresponding productivity gains that should come later this decade. As we have reviewed in the past, productivity can tame inflation if the government won’t. In addition, we expect corporates to spend across the board to invest in AI - as managers are getting pressure from boards to have an AI strategy.

This pressure to launch AI makes sense. Managers over 40 remember those companies that didn’t launch internet sites quickly enough. The challenge for businesses is to act now. Rather than launching a rudimentary website in 1997, many companies waited until 2007, to their own demise. Most companies must start somewhere with AI and it is better to get going now than wait until it is too late. This need to be relevant will drive some M&A, primarily because the war on AI today is over talent. Over time, acquisitions will turn from acquihires to buying real-world businesses with clear data moats that give them an advantage. Timing does matter, and the time for companies to do something with AI is now. 

One result of this pressure for corporates to use AI will create a lot of false positives. This means AI start-ups will see early revenue in B2B, but that may not be sticky or come in the form of pilots. Early traction doesn’t mean long-term success in this market.

We see and hear about AI in all parts of technology, but the reality is that it is largely simple use cases and implementations—for instance, email or chat writing, simple coding, QA, images, and co-pilots. Thus far the only practical AI applications we have seen in the B2B world outside of co-pilots are telemetry data, so managing devices and physical objects, or on the front-end CRM data decision-making. The progress we have made with AI isn’t that different than where we sat with the Internet in 1994, we had very simple use cases and huge beneficiaries such as Cisco and telecom providers (like NVIDIA) as the infrastructure was being laid for the future. Fast forward, the internet has permeated most aspects of our lives and businesses. AI won’t be much different in a decade or two, but perhaps with a much greater impact.

A mentor of mine once told me that today is the scariest the world has ever been. That is because we don’t know the future. Of course, so many bad things have happened in the past, but we know the outcome, so it seems less scary. Objectively, the average or median state of the human population has never been better off. We expect that trend to continue.

Let’s go! 🚀

Steve Sarracino

Founder & Partner

We are thrilled to announce our first-ever Genesis Summit, a conference for Founders, General Partners, and Limited Partners. The summit will be held in Germany, reflecting our investments in European startup ecosystems.

Join us for an intimate day of discussions and networking with other leaders through the investment and tech landscape, followed by festive Oktoberfest celebrations.

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Spring has sprung, and so have our latest research publications. Our team is in the weeds, looking at the different sectors in which AI is evolving. In our recent Quick Takes, we cover:

• Conversational AI and the Future of Customer Service—We dive into how today’s customer service technology is increasing pain points rather than solving them and how the new wave of conversational AI companies will reduce customer service workloads and improve business automation.

• Silicon Synapses for AI—We examine how NVIDIA's compute empire continues to dominate the hardware space, thanks to the scarcity of compute and reliance on NVIDIA within several stages of the supply chain, and explore potential opportunities in edge inference.

• We held our annual Women in Tech Happy Hour, which gathered our ecosystem of founders, investors, and senior operators. Thanks to everyone who attended, and we hope to see you next year!

Activant is a research-focused global investment firm that partners with high-growth companies, transforming the way the world makes, moves, and sells.

Founded in 2015, Activant has invested in category-defining companies like Deliverr (acq. by Shopify), Hybris (acq. by SAP), Bolt, Better, Celonis, Sardine, and many more.

The firm has $1.5B assets under management and is headquartered in Greenwich, Connecticut, with offices in New York City, Berlin, and Cape Town.

The Greene Street Observer is published monthly from Activant’s office on Greene Street in New York City.