Dear Investor

The start of the year is a great time to reflect on the past year, and to focus on the year ahead.

We saw the end of a decade plus long bull market for technology investing in 2022. Over the last few decades, technology investing has been punctuated by long bull markets with an element of craziness thrown in at the later stages followed by shorter and severe bear markets. The long-term perspective remains consistent; the valuation of high growth, early-stage businesses will increase at a very rapid rate over a long period of time but will fluctuate in the short term. The premise behind venture investing is very simple and compelling – it is a desire to have exposure to extraordinary businesses from the earliest stages of their lives.

The impact of poor markets was most pronounced in public markets. However, early-stage markets were not immune either and we have observed significant declines in valuations over the past year. Private markets are less volatile than public markets by design, but they also lag public markets. This latter variable means that we are likely to see early-stage valuations fall further throughout 2023. We have slowed the cadence of investment activity but are still very much open to investing in new portfolio companies that meet our threshold of excitement.

A lower valuation environment is clearly a negative for our current portfolio, while it is a positive in the context of our new investing activity. Our job is to be cognisant of the market environment and respond accordingly, but not be obsessed by it. Early-stage venture capital is a unique asset class in a number of aspects and one of the most important elements is that our returns are primarily a function of our ability to identify outliers, such as a Canva, Airwallex, ROKT or FinAccel, rather than primarily being a function of entry valuations. Access to great opportunities and great decision making are the elements that drive outcomes in venture capital.

In other words, our job remains the same.

Identify a handful of companies each year that we believe have a realistic path to becoming remarkable businesses, help those companies to the best of our ability and continue to aggressively back the emerging winners in our portfolio. Although our job is simple, we don't believe it is easy.

Why are we excited about the next few years?

Firstly, we have been able to demonstrate over the past decade that we have the team, the mindset and the hunger to deliver strong outcomes. We are very proud of the investments we have made in the past decade, and we have been able to back world class companies consistently across each of our vintages, geographies and thematic focus areas. As we have noted previously, we have been operating in a very strong bull market period up until late 2021 and that has been a tailwind for our performance.

We are particularly pleased that we have taken proactive steps throughout the 2019-2021 period to return substantial amounts of cash to our Limited Partners, and we are thrilled by the performance of our highest potential portfolio companies. We currently have eight portfolio companies that have annualised revenue exceeding $100m.

As we assess our own performance, we particularly focus on Fund Zero (2012-2015). This is the group of companies have had up to a decade to season, and there is a lot of objective data on the quality of those companies. The initial portfolio of Fund Zero companies has delivered a realised return (DPI) of 3.5x, a total return of 7.6x (TVPI) and a net IRR of 31.5%. We have already had two Fund Zero companies ‘return the fund’ from realised returns to date. By the end of this vintage, we hope that we will have three or four Fund Zero companies ‘return the fund’ on their own.

By any measure, we were learning the craft of venture during that early period, and have substantially built our organisational capability since then. We are just as hungry today as we were a decade ago, we have learnt an enormous amount, and have built a team that we believe has the capability and mindset to deliver outstanding returns for an extended period.

The heroes in our story are the founders we back and we are incredibly proud of all of them. We are proud of our founders who are succeeding beyond anyone’s wildest dreams, we are proud of our founders who are doing it tough and showing enormous grit and resilience, and we are proud of our founders who are right at the start of their journey and still figuring it all out. We brought over 70 of our founders together in Tel Aviv in September 2022 for the Founder Summit, and it was a special few days. (See link here for blog post on our Founder Summit). The drive, passion, and hunger to learn and desire to help each other were all on display. We are inspired every day by the founders we back and feel genuinely privileged to partner with them.

What is our current thinking on the next 'big thing’?

The past few years have been punctuated by enormous value creation for technology businesses as more and more markets are being disrupted by technology startups, but it hasn’t been a particularly exciting decade for innovation.

If we look at the period of the late 1970s and early 1980s, we saw the emergence of the PC, followed by the internet era from the late 1990s, and the rise of the mobile internet era from the mid 2000s. However, the last few years have not been characterised by a new ‘big thing’ in technology. There are numerous candidates for the next big technology platform or theme - from Web3 to the metaverse, to quantum computing or AI. The past year was a disappointing year for both Web3 and the metaverse, and the jury is still out on what these two areas will look like over time.

However, that isn't the case for AI. After decades in the wilderness, we have seen enormous progress in AI in the past 10-15 years, with 2022 being a real breakout year. If you want to get a sense of the potential of AI, we suggest you spend a few hours playing with OpenAI’s ChatGPT. It is great fun! When you play with ChatGPT, you should focus less on its limitations or what it is able to do today but on what it (and other applications) will be able to do in the future. The future is AI, and the future is (nearly) here.

The other thing that should get all of us incredibly excited (not just from an investment perspective but from the perspective of the future of our planet) is that more and more great founders are focusing on the challenge of climate change, with enabling technologies such as renewables having become radically more economic. We believe that some of the world’s largest companies will be built to reduce, manage and adapt to climate risk.

Over the coming years you will see us backing more and more businesses that are focused on AI, as well as businesses solving the challenges of climate change. We are convinced that the next decade will be a more exciting period for innovation than the past decade, and we couldn’t be more excited for the year ahead.

Thank you for your support!

We are grateful to all of our Limited Partners for your incredible support, and we are cognisant of the need to be great stewards of your capital.

Square Peg Investment Overview

All amounts are in USD unless otherwise stated.