Credit: In the past 2 years an increasing number of companies, particularly tech startups, have reached the unicorn mark: valuations north of $1 billion on the private market.
Some of them even have valuations over $10 billion, which mainstream news has coined a decacorn. However, the public market hasn’t matched the exuberance of Silicon Valley, and Unicorns that have tested the market in recent years have faced some challenges. For example, Fitbit (FIT) is down over 50% since its IPOs in early 2015 primarily due to decelerating growth and lack of innovation. Overall, more than 40% of unicorns that have gone public since 2011 are in line or below their final private market valuations.
Unicorns today (and decacorns) are choosing to stay private longer. In 2014, 11 unicorns went public; in 2015, 5, and through the first 6 months of 2016 the count is holding strong at zero. Many investors who thought they might see Uber or Airbnb have its hand at an IPO will have to wait.
The new dynamics in play today are a reflection of past performances in the tech sector but also the easy access to funding and credit.
How Did We Get Here?
Going public is often seen as a crowning achievement in the proverbial game of entrepreneurship. Founders and employees with a majority of their net worth tied to the company were finally rewarded for their hard work and dedication.
Lately this hasn’t been the case, and companies are staying private longer than ever. More investors are simply exercising prudence in the IPO process.
The regulations and limited supply of funding that once forced companies to go public have changed. The Jumpstart Our Business Startups Act (JOBS), passed in 2012, raised the maximum number of shareholders a company could have before disclosing its financial statements. Combined with a growing supply of private funding, this has enabled companies to stay private.
Why Are Companies Staying Private?
A recent study found the average age of a technology company going public in 2014 was 11 years, compared to 4 in 1999. Of the handful of companies to reach $10 billion valuations between 2004 and 2015, only 6 achieved that milestone before going public, which was unprecedented at the time. The recent influx in private funding has produced success once exclusive to the public market.
Some companies have struggled to generate traction as they are seen as being overvalued. The short-term focus of appeasing investors with strong quarterly results have hindered the progress that companies are making.
Nonetheless, the reality is that the public market dictates a large portion of the decision-making process and right now traders aren’t buying small tech companies. Investors have been more attracted to larger companies which are given a higher multiple at the time of their IPO. The companies with higher multiples have typically performed better from Day 1 onwards.
What Does It Mean for Raising Capital?
The private market has become flooded with capital from venture capitalists, financial institutions, and late stage investors. Even hedge funds have started to dabble in private deals because they generate better return prospects. The latest delay in the IPO market has forced investors to wait longer to realize returns than they did 5 years ago.
Late stage investors can no longer count on public offerings to generate returns while early round investors have been largely unaffected. Seed and Series A money is invested early enough that making a profit simply requires valuations to increase after each funding round. Since many firms are staying private longer and must raise capital every two to four years, private funding has significantly increased in recent years. Along with raising capital, M&A is also becoming an increasingly popular alternative to staying private.
Is That the Right Move?
An IPO should still be the main objective for any new company. Going public can legitimize a business and brand which many small companies are often missing. The visionaries in Silicon Valley understood that the best way to build a sustainable business and make significant change is by going public. From Bill Gates to Larry Page and Sergey Brin, all the greatest entrepreneurs eventually undertook an IPO.
Two specific factors can also make an IPO inevitable. First, if the company exceeds the maximum number of shareholders allowed to operate privately it will be forced to go public. This was the case with Facebook (FB) in 2012, which ended up mounting a premature road show.
At the time of its public offering, the desktop platform had plateaued and Facebook was in the midst of pivoting to mobile. The instability involved in shifting resources drove the stock down nearly 60% in its early trading months.
The second and more common reason is that investors and employees, who hold a significant stake in the company, are looking to liquidate their shares. It’s not difficult to understand that a liquid asset is more valuable than an illiquid one in the short term.
The clearest reason to pursue an IPO though, is to spur growth. Going public is a great way to obtain financing to scale a business, garner mainstream attention, and attract and retain key talent.
Concluding Remarks
Today’s companies are choosing to stay private longer than ever. It’s important that companies correctly time their public offerings in order to get the most out of their IPO.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
