Are IPOs The New Down Rounds?

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It’s become a meme in tech circles, “IPOs are the new down round,” venture capitalists quip.

The dreaded “down round,” when a startup raises capital beneath its prior valuation, is getting pushed back to the public markets. While most companies grow their value in the stock market, Square, Box  and Hortonworks went public at market caps that were lower than what late stage venture capitalists signed up for.

Square, which priced its shares at just $9 when it did its IPO last week, saw the stock rise 45 percent in its debut. Now valued at over $4 billion, the company still lost almost a third of its worth since its last $6 billion financing round.

And others, including Groupon and Zynga, were larger companies at the time of the IPO, but ultimately saw public investors value their businesses beneath what they were worth in their private days.

Many see these corrections and think of the B-word, “bubble.” At some point in the process, these companies are getting overvalued and the expectations come back down to earth.

“We will see several unicorns come public below their highest late stage private rounds,” predicts Max Wolff, chief economist at Manhattan Venture Partners. “This is part of an overdue and long-term healthy reset.”

There may even be “a few rescues where folks pay cents on the dollar,” Wolff added, anticipating doomsday scenarios for some highly valued startups.

Anand Sanwal, CEO of CB Insights, further warns that “if you are a company losing lots of money with subpar fundamentals…the private markets can close up on you.”

Companies sometimes have to go public to raise capital  — initial public offerings are fundraising events, after all. “So instead of taking a private market down road, you take a chance on the public markets. We will see a lot more of these,” Sanwal expects.

But others say the initial disconnect between pre-IPO investors and public investors is not necessarily a problem in the long-run. Some stock market investors could view these lower-priced shares as a discount. Facebook first struggled in the public markets, but has now gained more than five times its value in the past 3 years.

“It’s important not to read into the ‘IPO price’ too much,” said Atish Davda, CEO at EquityZen. “What matters is how Square continues to perform for the next decade.”

If Square can weather the storm of going public at a share price below their previous round of funding, other companies could follow,” added Phil Haslett, EquityZen co-founder.  

Surely recent hires at Square will be disappointed that their shares are worth less than what they signed up for, but some pre-IPO investors have protections built in. Nicknamed “ratchets,” select investors in companies including Square and Box had guaranteed minimum returns, so they did not lose out on the low-priced IPOs.

And most tech investors will tell you that these discounted IPOs are anomalies, that the bulk of the “billion-dollar startups” will turn out fine.

“Solid companies will embrace the IPO and do well after going public,” said Sanwal.

At least that’s what the Valley is betting on.

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