There was a time where the royal road for unicorns - startups whose value exceeds bn1$- was finding a good idea, to develop, grow and then go public to raise new capital.
Nevertheless, in the recent years, we have seen a significant amount of venture-backed startups delaying their IPO as long as they can even after a long period of growth. And indeed, firms that went public in 2015 were 11 years old on average, compared to 4 in 2001. So why are these companies feeling such reluctance to go public ?
"[...] larger, easier, and cheaper access to private capital for tech companies."
Firstly, we’ve lately seen a much larger, easier, and cheaper access to private capital for tech companies. Even mutual and hedge funds have started to turn their investments to private companies while they basically invest in public stocks. Consequently, startups sector is now flooded with large amounts of cash and companies are less tempted to go public to get the necessary liquidities.
Moreover, private company’s valuation isn’t driven by market’s law but is instead defined and negotiated by the firm itself, which is a clear advantage. But resorting to a private equity investor (PEI) to raise funds brings also and especially multiple benefits the company couldn’t have if it turns public, namely network and knowledges. Indeed, a PEI provides an exclusive access to its network. It is an undeniable opportunity for the company to expand its interactions with new customers or suppliers. PEI also plays a role of advisor to help the concerned firm to keep growing.
This current remain-private trend is also due to a new investment model that was originally initiated by the data-analysis company Palantir, allowing companies to sell stocks without resorting to an IPO. Indeed, whereas companies employees and early investors had traditionally to wait the IPO to sell their stocks, they are sometimes allowed to sell a limited part of them to private investors. Therefore, the pressure applied upon companies to go public has significantly diminished.
It is also relevant to note that firms are delaying their IPO even further since the JOBS act was ratified in 2012. This law intended to spur startups and business activity notably by raising the amount of shareholders beyond which a company needs to go public from 500 to 2000. This clearly increases the amount of cash companies have access to.
Another undeniable reason urging firms to dwell private is that keeping the ownership into private hands means they have the appreciable freedom to choose their investors and keep their own strategy. Indeed, when listing, firms are subject to the Securities and Exchange Commission (SEC) which assumes the role of financial markets supervisor and investors protector. The SEC imposes all listed companies to release an annual and detailed report of their finances. We thus easily understand that companies are not always willing to disclose extensive information such as profit margins or business plans and prefer to keep them hidden from competitors. Companies wishing to go public also have to conduct a corporate governance that complies with a whole set of rules.
The WeWork case particularly highlights the consequences that non-compliant Corporate Governance has on a company which is about to be listed. Indeed, the co-working space company’s founder, Adam Neumann, powerlessly saw the initial bn47$ offer valuation plummet to less than bn10$ last summer in just over one month pushing him to pull his expected IPO project altogether. This sudden tumble was mainly due to bad executive behaviors revealed in the S-1 filing submitted to the SEC . The CEO has indeed used the company to make profits for his own account and had, for instance, rented personal properties to the company. Worse, he even had trademarked the word "We" to thereupon sell the rights to WeWork and eventually pocket the astonishing sum of 6 millions dollars. In addition, Adam Neumann used to have the majority of voting power centralized in his hands which led him to take decisions on its own which were often bad. This poor corporate governance coupled with an overvaluation led one of the most 2019 anticipated unicorn’s IPO to the worst fiasco the public market has ever seen. It now seems that the time where investors were tolerating bad corporate governance as long as they were making large-scale profits has come to an end.
2019 IPOs failures:
Last year, we saw some of the most anticipated IPOs failing, and not without reason.
In may 2019, 10 years after its creation, the famous unicorn, Uber, went public and saw its share undergoing a sharp 8% drop below its IPO price from $45 to $41.57 on its first trading day. Almost one year later, its stock is still struggling to sell above $30. For its part, Lyft, the ride-hailing company was trading 25% below its initial listing price only a week after its IPO. Uber and Lyft have been ranked among the top 3 companies with the largest losses in the year prior to their IPO according to Renaissance Capital and are not supposed to be profitable before 2021 at least. Another big tech firm to have stumbled in 2019 was the professional messaging app, Slack, which had gone public through direct listing - without new shares issuance- and has since seen its $38.50 listing price relentlessly fall and turn out to be now trading at around $25. In its annual report, the firm has shown this plummet was mainly due to a weak guidance, a slowing revenue growth, losses forecasts as well as an unclear path to profitability.
We can first note that these “promising” unicorns may have likely waited too long to go public. But we can also highlight other common aspects between them: they are all companies flooded with private capital intended to artificially boost their growth and conceal their astonishing losses. These situations have also unveiled the significant gap existing between public and private valuation.
Figure 1: Uber stock
Figure 2: Lyft stock
Figure 3: Slack stock
What about the 2020 most anticipated unicorns IPOs?
"The COVID-19 crisis is [...] fanning the flames on an IPO market which was already in a bad situation beforehand. "
Before the crisis, the bn31$-valued unicorn, Airbnb, was expected to eventually go public this year after near 12 years of existence. However, it is quite likely that it will be postponed once again following the current pandemic crisis. Indeed, travel market is acutely impacted and the after-effects could be felt for still a long time to come. Airbnb is thereby considering to finance another round from private investors. Meanwhile, Postmate, the 9 years old Californian food-delivery company that had already put off its IPO in 2019 to 2020 could also delay it even further. Though we could think that confinement measures as well as closed restaurants could be an opportunity for delivery sector, it seems that gig-economy workers are rather reluctant to keep delivering in these unsafe conditions. The company is thus also stuck in a period of high uncertainty. It is also relevant to mention Palantir, the Big-Data company -and a reference in IPO delays- founded in 2004, that was reportedly supposed to be listed in 2020 and had finally announced in 2019 it wouldn’t be the case before 2022 or 2023. Its chairman, Peter Thiel had indeed asserted to be in talks with private investors to raise significant funding. Despite the company was expecting to generate bn1$ this year, it has never been profitable so far and the current crisis could jeopardize its initial goal.
The COVID-19 crisis is therefore fanning the flames on an IPO market which was already in a bad situation beforehand. A relevant indicator that will tell us that the IPO market would be ready to recover is the VIX which measures the level of volatility in the markets. Investors often claim that above 30, they prefer to rule out any IPO idea. It is therefore unconceivable to foresee any company to go public in the near future while VIX is wildly hovering between 35 and 75. (figure 4)
Figure 4: S&P 500 VIX index
Last but not least, we've seen multiple reasons urging big companies to remain private the first of which is a private market particularly keen to provide unlimited amount of funds to the startup sector. However, this easy money entail unbridled growths that do not correspond to their actual profitability. These overvalued companies often go back to the grim reality once listed on the stock markets. And Uber, Lyft and Slack have experimented it. Therefore, we can draw lessons from these failures. Companies wishing to go public now have to do an effort to improve their communication with public equity investors who are not used to these venture-backed unicorns and explain them what is their accurate path to profitability and that though they can be losing money for a while, a lot of progress are made made to enhance value creation.
Beside this, startups are also and often not prepared to disclose their corporate governance and fear the risk of following in the footsteps of WeWork. There also and always is a risk for the IPO to fail because of a lack of public interest and that this a time-and- money-consuming process couldn’t be so advantageous in front of all the opportunities offered by the private equity market.
Finally, it is obvious that the sanitary and economic crisis the world is currently facing will be an additional reason for most of the companies to delay their IPO even further. Remains to be seen whether the Private Equity and Venture Capital market will be able to cope and to provide as much liquidity as they have for the last two decades.
Edouard Wauquier - Head of Corporate Finance