The IPO market is poised to make an almost complete 180° turnaround after a bleak Q1 and a very quiet summer. JPMorgan alone said they were launching 20 global IPOs, and has successfully launched nine in the U.S. to strong demand. The broad market (S&P 500) has largely recovered, as well, from a low point of 1,810 earlier this year to a current (near) record level of 2,193 (as of September), a 21 percent move.
In contrast, venture capital investments, which had recalibrated alongside the IPO market in the second half of last year, have remained sedate with a clear flight to quality; fewer rounds, for higher-quality companies, with larger check sizes.
Private funding activity cannot recover as fast as the public markets. While the music seems to be back on at the IPO party, aspects of the private market re-calibration may be permanent. Eighteen months ago a SAAS company with $1 million of revenue in their first year of operation would have had a solid shot at a Tier 1 Series A. Today, those companies go wanting, resorting to “second seeds” and “inside rounds.”
The public markets
The IPO window quickly cooled in August of 2015, marked by the BETR and RUN IPOs. Both were significantly oversubscribed deals that opened and traded poorly, as they weren’t able to attract real buyers/holders.
The buyer fatigue was palpable. IPO volume dried up and a buyer’s market set in.
A few IPOs dribbled out over the remaining months of 2015, with only two notable tech deals: SQ and TEAM. This was followed by an almost complete freeze at the beginning of 2016.
This closure was very well publicized, with pundits claiming it was because of market volatility caused by any number of factors, including the election, oil prices, the Fed raising rates, Brexit, China/Brazil economies, etc. There’s been little resolution to many of these factors, yet investors have still regained an appetite for IPOs.
Insiders claimed there was a complete shift in investor sentiment from growth to value, or more specifically to growth with value in the form of profitability or an obvious path to it. Investors were also concerned about debt-laden companies. This message reverberated across Silicon Valley, where companies were advised to decrease burn and show sustainability by demonstrating an ability to make money.
Tech multiples, which compressed significantly at the beginning of the year, have recovered, but not to levels as lofty as early 2015:
- Cybersecurity (hardest hit): Currently trading at 5.19x versus 9.11x in July 2015
- Saas: Currently trading at 4.61x versus 6.21x in July 2015
- Internet Names: Currently trading at 5.83x versus 5.69x in July 2015
- Adtech: Currently trading at 2.13x versus 4.26x in July 2015
Two months ago, the general consensus was that the IPO market would shut down until at least 2017 — essentially 17 months with almost no IPO deal flow.
Then there was Twillio!
June 22, 2016, Twilio (TWLO) priced at $15 (a healthy premium to the last private round) and traded up 92 percent day 1. Since then, TWLO has traded up 278 percent and the IPO window has opened wide.
Just like that, IPOs are back in favor… all fear evaporated, all hesitation erased without any resolution to the supposed issues that precipitated the pullback originally. Perhaps all anyone needed was a breather in the shape of the most severe IPO drought since the recession.
The private markets
Private company fundings followed the IPO market’s lead dropping from 1,333 in Q3 2015 to 1,137 in Q4. Deal volume stayed suppressed through Q2 2016, and this year is on pace to be slower than 2012.
Opportunity is knocking for VCs willing to go against the grain.
Dollars raised in 2016 versus 2015, but not as significantly as deals quantity; fewer deals for larger dollars were done for the biggest and best private companies.
As the IPO market cooled, private funding showed an even more severe and immediate flight to quality. Uber and Snap alone account for $4.5 billion of the $31.8 billion in U.S. VC-backed financing in 2016. High-flyers like Slack, Airbnb and Spotify also commanded sizable rounds at, often, sizable prices.
Select innovative sub-sectors, such as artificial intelligence, insurance tech, autonomous driving and virtual reality also saw demand and excitement in line with early 2015 levels. Otherwise, venture investors have returned to more cautious, diligence-focused investing, as they had before unicorn euphoria hit, and with the complete retreat of crossover investors, venture remains largely a buyer’s market.
The bias toward proven stories has led to a significant decrease in the number of unicorns created in 2016. Twelve unicorns were created in the first two quarters of the year, compared to 49 in Q2 and Q3 of 2015.
What the future holds
With stocks touching all-time highs, and IPOs once again coming to market (and performing), the public market recovery is clear. Banks have said the IPO market will remain extremely active through the end of the year and into 2017.
The cracks in venture can’t be repaired that quickly. Renewed VC prudence hasn’t slowed down innovation, but it has slowed getting that innovation through the funding machine.
There has been a meaningful shift in VC interest in a company’s technology to the company itself. VC investors want to see infrastructure, track record and reliability, not just the next big idea. The rhetoric of “tell me how you are going to become the next billion-dollar business” has turned into “tell me how you are going to make this a sustainable business.”
So the large, clear winners still attract a buying frenzy, but it has become much harder for most companies, especially smaller companies, to raise. However, opportunity is knocking for VCs willing to go against the grain that have now been given more time and pricing power to selectively uncover the next unicorn.