SA国际传媒

is the CEO and co-founder of . Vineet has over 20 years of experience building capital-efficient organizations, and he has worked with Trinity Ventures, Kleiner Perkins, Google Ventures, Floodgate, and others.

There are many reasons that a company decides to go public. One main reason is to raise money for the company to expand its business and move to a bigger stage. Another is to create liquidity for investors, founders, and employees. From a public perspective. it鈥檚 easy to see why the IPO is often considered the 鈥淗oly Grail鈥� in terms of exits for a startup.

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With roughly a quarter and a half left to go in 2017, we have still yet to see IPO filings from some of the biggest names in tech鈥擜irbnb, Dropbox, Pinterest, Palantir, SpaceX, Uber, and more鈥�. By all accounts, these are seemingly successful companies with hundreds of millions, if not billions, in revenue. With all the potential positives, why is everyone hesitating to take their company public?

There is only one place to look: venture capital.

The Venture Gamble

Venture capital firms have minimized the financial pressure on private companies to go public. This is mostly thanks to oversized late-stage funding rounds accompanied by inflated valuations.

While many won鈥檛 admit it, investors are hanging themselves by their own rope. As many of portfolio companies mature in this non-GAAP era we are currently living in, late-stage companies struggle to hit important GAAP metrics for a successful public market debut 鈥� things like growing net revenue, and an improving net income result. Therefore, instead of facing a potential slaughter on the public market, startups go back to VCs for more funding.

For a VC, this is a tough spot to be in. Investors don鈥檛 want to lose their initial investment if the company falters; however, for these late-stage funding rounds to be worthwhile for the VCs, the investment needs to be much larger. In turn, the late-stage startup must accept a higher valuation. The side effect of this late-stage funding is that it typically provides a much longer runway for startups to stay private and not have to deal with the pressures of answering to the public in the form of earnings reports and stock price performance.

The Valuation Trap

When I make this argument, this is where many people get very confused about private valuations, thinking that a high valuation completely dooms a company.

However, that is not necessarily the case and I will give an example:

Think about a private company that currently has $100 million in annual revenue, with a post-money (most recent round of funding) valuation of $750 million. They are getting a little low on operating cash because they are still spending roughly $150-160 million a year. The CEO wants to wait until they are cash flow positive before he or she takes them public so they have no choice but to take another round. At this point, the term sheets they get from VCs want to offer them $100 million in funding at a $1.2 billion valuation, but it also offer protections so that if the company doesn鈥檛 reach $1.2 billion then the investors will get their $100 million back. With no other options, the company takes the money at a valuation that is well overpriced, knowing that worst-case scenario is they just have to give back the initial investment.

As you can see, the company鈥檚 sensitivity to the valuation is very low since they needed the money and there are protections built in for the investor anyways. As a result, the company has plenty of cash on hand and they can take their sweet time in terms of securing an exit. The only downside is that they鈥檝e now made a hot seat for themselves when it comes to public perception. These late-stage startups will be constantly poked and prodded with questions concerning an IPO announcement, fulfilling the now-higher valuation, and raising enough money on the public market.

Looking at the numbers today, the SA国际传媒 Unicorn Leaderboard that there are currently 263 private companies that are part of the worldwide unicorn club, a cohort of companies with valuations of $1 billion or more. Those 263 companies have a combined valuation of over $900 billion and have raised over $168.8 billion in funding.There are a number of companies in this group who have an inflated valuation that is a direct result of taking a late-stage funding round.

Look at a company like Airbnb, for example, which just raised $1 billion in funding in March. From what we know, they have a very solid growth story and strong financials, so what does that tell us?

1. They received a $31 billion private valuation that they may or may not fill. But as we have learned, there are likely protections built in for the investors.
2. Airbnb bought themselves a longer runway to make sure their books are as strong as possible when they do decide to make their debut.

So while all signs point to Airbnb continuing on a聽successful path as a private company,聽the public鈥檚 thirst for yield will now聽put a significant amount of pressure on them to file聽for an IPO as soon as聽possible. With that kind of contrast in sentiment, it’s no wonder聽that聽everyone is having a hard time putting a read on tech companies these days.

I understand the need for VCs to diversify and make聽late-stage investments that are聽relatively safe or protected. I also understand聽the need for companies to take money in the聽late-stage to sustain growth and聽push for profitability at scale. However,聽I believe the unnecessarily large rounds that are soaring past the nine-figure聽mark聽are where this has gone wrong.

Most companies do not need two, three, four hundred million聽in funding in order to get聽them to an IPO and, thus, should not be offered that聽kind of capital at that stage. While it聽doesn鈥檛 inherently hurt the company to聽take the large investment (as explained in the聽Airbnb example), it creates聽detrimental exuberance and unrealistic expectations from聽the public. For those who are not well-versed in the聽dynamics of venture capital investment聽that I鈥檝e explained here, what they end聽up hearing and seeing on the news only makes matters worse鈥攅specially聽given聽the lack of credible, publicly available information about private companies.

Pair that with the recent missteps by Blue Apron and Snap聽Inc., and you now have some聽very muddy waters when it comes to the tech IPO聽market.

With all of that being said, I do believe there is a light聽at the end of the tunnel.

With companies getting larger injections of capital it is聽creating longer runways for聽startups than ever before. As a result, VCs are聽experiencing longer wait times to see a聽return on their investments and thus聽capital will start to dry up. Once the available聽capital starts to dry up, VCs聽will have less money to throw around for these large late-stage investments and聽they will put more pressure on their portfolio companies to make聽an exit in聽order to create ROI.

This chain of events will put focus back on fiscal聽responsibility and create a more unified聽view of what a successful company聽looks like. From there, all it will take to spark聽momentum is for one聽IPO聽hopeful with a strong balance sheet to debut and maintain鈥攆or two-to-three months鈥攁 strong price. I believe that such an IPO will happen by聽the end of the聽year. This will open up the doors to a resurgence of the tech IPO market in聽2018.

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