Startup valuations drop as exits are delayed and the stock market reprices tech

Hello and welcome back to our regular morning look at private companies, public markets and the gray space in between.

The public markets are in turmoil as the economic impact of COVID-19 comes into focus; however, it is less clear what the impact of the changing value of public companies today will have on the valuations of private firms.

Startup valuations are impacted by a host of factors, one of which is the value of their public comparables (comps); if public comps lose value, private startup comps tend to earn lower valuations. This leads us to a key question: Are the stock market’s recent declines impacting the value of private startups?

To get an answer, TechCrunch spoke with Phil Haslett, the chief revenue officer at EquityZen. Haslett is a founder at the company, which helps owners of stock in private startups sell their shares to interested buyers. We were curious if there was a noticeable impact on prices so far and how demand might be shifting on both sides of its marketplace.

Public prices, private values

Our chat was initially predicted around EquityZen’s new list of startups that it anticipates going public this year. However, as the world’s IPO window has slammed shut, EquityZen’s predictions of which companies will go public (AppLovin, Asana, Desktop Metal, Druva, and Sprinklr) are now little more than list of candidates effectively benched by forces outside their control.

So instead we talked about the impact of changes in the stock market on private valuations, starting, interestingly, back in 2016. According to Haslett, the early-2016 SaaS crash in the value public software companies did impact startup valuations. However, it took a while, something in the order of months.

Why did it take so long for technology revenue multiple compression (falling stock prices impacting key valuation metrics) to impact private valuations? Haslett reckons it was due to relatively slow price discovery at the time, impacted in part to limited secondary trading for private shares. Add in the fact that primary transactions for startup equity (the Series A and Series B rounds you read about on TechCrunch every day) are infrequent, the new valuation for SaaS companies took time to make itself known in startup-land.

Things are a bit different today, according to Haslett. As the secondary market has grown and matured, price discovery takes less time today; now the impact of a changing valuation world can be felt in private companies in weeks instead of months.

It has been weeks since COVID-19 began to roil global markets. What then is the impact that we’re seeing on the value of private companies? It’s precisely what you would expect.

Down

Let’s start with trading volume. According to Haslett, a few weeks ago volume was light. In his view, market participants were trying to figure out where everything stood. Then activity began to pick back up on EquityZen last week, he said.

Next let’s talk prices. There’s always a discount for private shares compared to the company in question’s last private valuation. This means that if, say, Alex Wilhelm Inc. was worth $1 billion on paper, and I owned $100,000 in shares of the company, I should expect to sell those for a small discount if I wanted to offload them while AWI was still private. Why? Liquidity and the premium it commands. It works out like this: I have illiquid shares (private stock is not as easy to sell as public stock), and you have cash. You want my shares; I want your cash. But you know that you are going to buy stock that will effectively lock up (freeze, in liquidity terms) your capital for a while. In contrast, I’m getting cash, the most liquid thing there is. So, you demand a discount on the price of the private stock to compensate you for taking the illiquid asset in the trade.

Got it? You can expect about a 10% discount in regular times if you want to sell your private stock, according to Haslett. That has risen to about 25%, according to the data that Haslett shared with TechCrunch. That change is material but not catastrophic.

Its material in that a decline of 15% compared to a putative asset price is large. But then change is also not catastrophic in that there is still a market for illiquid startup shares, and the decline appears to be less than what we’ve seen from stocks in recent days. However, with the Nasdaq down more than 25%, there could be more price discovery yet to come; the discount-to-last-private-valuation could still rise.

Why are people still buying illiquid startup shares? According to Haslett, those who were irked about the prices of some companies are now being offered those same firms at an effective discount. Why have all that dry powder if you never load the musket?

For startup employees, the takeaway from today is that the should expect to take a larger hit if they want to sell early. For startups themselves, the change in their market value should be an early warning system ahead of their next round, at least where valuations are concerned.