Happy Sunday, fellow startup nerds.
Today we’re talking about risk in the gambling sense of the word. You see, there’s a way for unicorns to avoid painful dilution when they next raise capital, and it appears that a good number of the world’s billion-dollar startups are taking the wager. But new data indicates that the bet some of the most well-financed startups in the world are taking could be more wishful thinking than intelligent gambit.
Here’s the gist: Unicorns, many of which raised capital during the 2021 boom at valuations that no longer square with market norms, are holding off raising capital until conditions improve. The bet they are taking is that they can survive off their last cash haul long enough to make it through a valuation trough and raise on the other side, when prices improve.
To understand what’s going on, let’s talk unicorn funding events, the state of valuations and how much longer things might be Somewhat Shit when it comes to revenue multiples. This is going to be a bop.
The state of unicorn funding rounds
When we consider funding events that create unicorns and what they raise after they reach the valuation threshold, we tend to focus on nine-figure rounds. These events, worth $100 million apiece or more, are sometimes called “mega-rounds” as they are, in fact, mega-big. And they are in decline.
Per a peek at Crunchbase data, there were some 418 mega-rounds in the world in Q3 2021, discounting private equity deals to constrain our lens to the venture capital world. In the second quarter of 2022, as the venture capital market slouched further into its current posture, the number was 334. Thus far in the third quarter? Just 150.
From this, we can infer that unicorns are not raising as much capital as before. But with a record number of unicorns theoretically around today, how can they keep eating if they are collecting less cash to consume? The answer is a mix of burn reduction and prayer.
How low are prices today?
Why don’t unicorns simply raise more capital at the market-clearing price today? Because not only have prices come down sharply for technology companies big and small, public and private, but they’ve reached a nadir so low that it’s the worst valuations climate for quite some time:
Altimeter Capital partner Jamin Ball has the latest:
The median cloud software NTM revenue multiple is now 5.5x, which is a 5 year low. The last time the median multiple was lower was late 2016 early 2017. The covid low (March 2020) median multiple was 6.6x (20% higher than where we are now)
— Jamin Ball (@jaminball) September 21, 2022
In more conversational English, Ball is noting here that among software companies on the public markets today, half are trading below 5.5x times their next year’s revenue. Half are trading above that rate — that’s what median means — but the benchmark figure is shockingly low if you became inured not just to 2021’s excessive valuation marks but even the more modestly temperate valuation climes that we saw in the years heading into the pandemic.
Recall that we saw more mega-rounds last year than you could shake a stick at. They were landing at a simply bonkers pace, creating companies with high burn rates — startups built to consume cash and grow. Today, profitability is perhaps commanding a larger premium than growth, meaning that even quickly growing unicorns are looking at a valuation market that is worse than it has been in the last half-decade and also one that views their key characteristic as somewhat passé.
So why don’t unicorns simply raise more capital at the market-clearing price today? The answer, given the above, is that if they did, it might come at the cost of most of their valuation.
And so many unicorns are avoiding reality by not raising today, hoping that valuations recover and growth reattains its prior premiums and market prominence. Will it work?
The unicorn overhang
Probably not? The thing about the stock market is that it impacts all startup prices over time, just slowly. This means that pain from the public markets can take a while to trickle backward into startup valuations. And with public shares in tech companies continuing to lose value, it stands to reason that we could see more valuation pain for startups. And, therefore, more pain for unicorns.
And public markets aren’t budging on valuation, it appears. Per GGV Capital’s Jeff Richards:
Met up with a top IPO banker on Friday. “How much demand is there for IPOs right now?” “Zero.” “What if companies adjusted valuation expectations to match public comps?” “Oh. Yes. We’d have a ton of demand.” 🤔
— Jeff Richards (@jrichlive) September 18, 2022
Unicorns are therefore frozen out of the private capital markets at today’s prices and their own valuation demands, and IPOs are not here to bail them out.
How does an all-time record number of high-priced, high-burn startups survive when they can’t raise from anyone at a price that they like? Many don’t, right? Perhaps the rumblings we’ve heard about impending deletions of even some well-known startups are more than just rumor and concern.
Yeah, but …
The flip to our argument today is that unicorns aren’t voluntarily opting out of raising mega-rounds — they can’t raise them. No one will write them a check at that dollar amount. To which I would say, fair enough, but the quibble doesn’t change the substance of our point. Unicorns could raise eight-figure rounds, sure, but the same valuation disconnect would still be at play. A smaller round wouldn’t make the constituent valuation pain any less real and would bring with it less cash. So it would be a double-downer — less money in the door at the same, or similar, valuation cut.
If the stock market doesn’t start to gain steam soon, there’s little chance that private-market valuations will be able to recover in time for many unicorns to raise capital at a price that they are willing to accept. At some point, the pain will reach a level that more unicorns will choose to raise. But many won’t be able to, and they may wish they could go back and take on that same pain earlier on — before things got even worse.
Then again, who doesn’t love a gamble?
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