Maybe They Do Understand Your Business
Farhad Manjoo has a piece in the NY Times discussing something we’ve been talking about ad nauseam here at AVC in the past year or two, namely that venture backed tech companies are waiting much longer to go public and in the process creating a “private IPO” market which in turn is increasingly putting huge valuations on a large number of venture backed companies, including a bunch of USV portfolio companies.
There is an unfortunate quote in Farhad’s post which suggests that the public markets are clueless:
If you can get $200 million from private sources, then yeah, I don’t want my company under the scrutiny of the unwashed masses who don’t understand my business
First, the public markets are not “unwashed masses.” They are full of very sophisticated investors who, I suspect, do understand these businesses very well.
It is true that Wall Street will not be tolerant of missed expectations. It is true that Wall Street may focus too much on short term numbers. It is true that you may not be able to control what numbers Wall Street decides to obsess over when it comes to valuing your company.
But I think tech sector is making a huge mistake in thinking that they know their companies and how to value them better than Wall Street. That kind of thinking is arrogance and pride comes before the fall.
Comments (Archived):
The market is always right and the customer always smarter than you give them credit for.When we fail, it is always on us.
so true
Always true about the consumer market. True in the long run about the stock market (Ben Graham: “In the short run, the market is a voting machine; in the long run, it’s a weighing machine”). The difference is that consumers buy based on what they want or need now, and stock market investors buy based on what they think the stock will be worth in the future.
Yup. When a company I invest in fails-I look at myself and how I made mistakes analyzing it. When I trade poorly, it’s on me.
bingo
True, but they do exhibit periods of “volatility”.
Markets can stay irrational longer than you can stay illiquid.
Is it possible that the larger the market ownership of a co., the higher the likelihood of a true ‘consensus’ appearing on the company value, compared to a more tightly held private co. where vested interests and greed are more likely to play a part in valuation?
The average investor is subject to the inherent losses of behavioral finance, where a 50% chane of loosing $100 vs 50% chance of a $120 return is risky vs a lottery event.
I think having your shares in a larger number of hands is beneficial to the stability and growth of the company in the long run. But going public with a sky high valuation is gonna get you a haircut whether you want one or not.
What contributes to this mindset?
Pride / arrogance 🙂 and the reality that indeed many of the business models are speculative, so they don’t have the predictability of most public companies. Investors like some basis to actually value cash flows (current or future).
easy pile oi cash is pretty enticing
I agree.But this idea that anything about building a startup is easy is just silly.It’s a hard way to live.When startups cash out-I say good.The percent of losers who don’t gets greater all the time.
No question. It is the much tougher route and being made tougher by crazy money. I don’t like seeing companies work so hard to get public and then have a huge mess because their worth is out of whack with reality.
The truth is that it is always a mess. I”ve only been inside the board room on a handful of these but in business it is never without its diurnal spikes and craziness.
The percent of losers who don’t gets greater all the time.Danielle needs to do a PSA on that with her compiled data and stop just selling sugar water to children. [1]The unfortunate part is that from the outside there are people waking up every morning wasting a great deal of time and money tilting at windmills and trying to do both smart and stupid ideas that have little chance of ever working. One reason is that there is really nobody highlighting the great degree of failure in a way that makes it easy to see how little of a chance of success there actually is. It is a true “throw it at the fan and it might stick” environment. For sure there are stories here and there but nothing that in any way kills the gold rush mentality. (Danielle is selling pick axes btw.) Plus those that fail always seem to have the type of internet fame that leads to something else good for them. (But that is for those at the top of pyramid not for ones at the middle or bottom.)Here’s the thing. Back in the day when it was actually quite hard to start a business (out of college when most got “real” jobs) you didn’t step forward without giving thought to whether your idea had a chance of succeeding or not. There were significant barriers to entry in doing almost anything that you could think of. And typically you used your own money that you had saved up (or perhaps family who thoroughly vetted your idea because they were not starstruck like some are today because of all the publicity surrounding startup “success”).Today for many reasons it’s easy to get swept up and start something on impulse. Both because of available angel funding [2] but also the wealth of available information on how to do just about everything that you need to do. Back in the day all of that took time and effort and at any point on that curve there were multiple chances to back out as opposed to being able to almost literally hit a button and go forward with your impulse (which now is perhaps driven by greed and jealousy).[1] Would definitely get press mention with that one for sure.[2] And as mentioned your friends/family are more likely to give you money because they are starstruck and have been brainwashed by the outliers.
great comment. Long…but very good.
I think Dick Costolo sums it up well: “You always want to keep focused on the long-term vision, yet when you go public you’re on a 90-day cadence and there’s a very public voting machine of the stock price that accelerates that short-term thinking.”
What a great point.
I think it depends what stage you are at. If you are still searching for a business model I think I may make sense to stay private. Also a competitive advantage in that you don’t have to disclose much information like you do once you go public (I get that the jobs act has some things here which reduce how much info you must share.. did I read correctly that etsy is taking advantage of that option Fred if you can comment). I mean, I definitely think much of the late stage investing is crazy / “a bubble” but imagine if snapchat was public… how brutal would it be for them? or pinterest? I mean, neither may end up being really great investments long-term, but they would have almost no chance I think if they were subject to quarterly calls with questions such as “so you still are under <$50 million in revenue.. what are you doing about this etc”
Also, I bet every founder has to look at twitter’s experience and be like “nope, don’t want that”. Twitter is around $25-30 billion I think, doing multi billion in revenue, and the narrative makes it often seem like they could be gone come tomorrow (I know this is not the case). But if they were private still, they would be able to talk about how fast revenue was growing, and how they had so many users etc.. and it would be much easier to make changes / test them out I believe. I get they / and you fred as investors need liquidity eventually but I don’t think the public markets have been kind / helpful to twitter, but you have more experience with them so perhaps it has been?
Personally, I prefer to test business model / making money as early as possible. Obviously there is a bet to be made in terms of growth & revenue, hence the point of VCs and founders working together…but should that bet be in the billions of dollars range for things like market share and % of engaged users? It’s tempting to play that game….
I mean, I sort of agree and definitely by the time my company is worth billions will know the business model :). But take pinterest or snapchat. Pretty much we know only business model is advertising, but what TYPE of advertising etc. is to be seen. They both have raised money at maybe half of what twitter is CURRENTLY valued at… I don’t think they are that valuable. However, if public, they would not have time to iterate on multiple business models without much more prying from wall street and others
But how much is Pinterest or Snapchat really worth? I agree with you, but there is something intrinsically problematic about $1bil+ valuation and pouring hundreds of millions into a company that doesn’t really know what business they are in. I think there is a sort of confusion about seed vs. growth – I was looking at Tom Tunguz chart the other day ( http://tomtunguz.com/startu… ) and I couldn’t help but think that a company in search of a business model, that’s not growth that’s seed.And if you’re handling that much $, shouldn’t you be subject to some scrutiny? I I suppose it is always a call to be made, but at the top end there is a real problem, and just the fact that everyone who’s been in the VC or founder game for 10+ years is saying “well I’m not declaring it’s a bubble but…” reinforces that.
By any reasonable multiple these late stage tech companies are overvalued by 10x. I can run through some quick revenue, EBITDA and growth multiples to easily show you, as can any banker with 3 months of tech experience. VC’s have too much money and are inflating late stage valuations to take deals away from traditional growth. Market will crash, and it will be fun to see how many founders learn that investors walk away with everything when something doesn’t go right.
For some definition of “fun”….
EBIDA on Amazon in 1999, EBIDA of Netflix when they were a mail order DVD company …
I remember right before the meltdown in 2001 when I heard similar things. “This is the internet, it’s new and they just don’t understand it”. Fortunately, I kept my discipline then and wasn’t long-and got a little short. I was short again in 2008. There is going to be a day coming soon when you sell everything you have including all your animals and children. Don’t worry about the children, you will be able to buy them back cheaper. China’s market is down 25%. There isn’t a bubble in US public markets-but there is an anomaly called 0% interest rates and QE forever that has propped them up.
“This time its different”. Amirite?
The phrase “This Time is Different’” can be tricky because it is wrong for the wrong reason.Many times, people use it rhetorically to imply this time is not different (not saying that’s what you implied :-)).The counter-idea to “This Time is Different” isn’t “This Time is NOT Different”.The counter-idea to “This Time is Different” is “EVERY time is Different”.April 2000 was different from October 1987 which was different from October 1929. We can go back to the South Sea Bubble where Sir Issac Newton lost a fortune. Human Nature was the same, other things were different.The folks who will be prepared and possibly profit when the nextcrash comes will be those who understand ‘how’ this time is different from the previous times. Thanks.
You make a good point about every time being different, but there are similarities that get ignored, every time. Investors becoming over comfortable with risk (during booms) and over scared of risk (during busts) is one such pattern.Of course, hindsight is 20/20 and iit is easier to see these similarities after everything is over and done.
You are right..like I mentioned, human nature and behavior remains the same every time. That won’t change..bubbles will happen, lessons will be forgotten, crashes will happen.”History does not repeat itself, but it does rhyme” – Twain.”Those who forget history are condemned to repeat it” – Santayana.But that it is at a level of abstraction. When looking at financial markets today, that doesn’t move one’s understanding forward. It may not prepare you for what is coming, or to sift the signal from the noise. And there will be a lot of noise in the months to come.A level of abstraction is useful after understanding the differences (dis-aggregate, then re-aggregate), but doesn’t help as a substitute to understanding the differences.
Correct me if I am wrong but a basket of VC investments into things that “they just don’t understand” is not the same as a basket of diversified investments into stocks in the public market. There are very few huge wins in the public market even if they are held onto long term, right? Arnold mentioned a friend that had shares of Apple that they found and had forgotten recently or perhaps the little old lady that had Berkshire shares but how rare is that type of thing? (Out of the thousands of possible investments that anyone can buy and hold I mean). VC or angel funding is based on the big outlier win public stock market investing is something entirely different with a different risk analysis of the business model. (Isn’t it?).I guess my point is at a certain stage on the investment curve (if you want to call it that) the fact that you “just don’t understand it” is less important because you are getting large potential shares of something at (in the past) a lower price that might eventually pay off in a big way. [1][1] The “thing” that I have “invested” in works that way. I have bought a large number of these “things” at an almost trivial price with the hope that at some point people will pay a large amount of money for them. (And yes that has worked btw.). Anyway who didn’t buy when I did in no way shape or form can compete with me. People would think “this doesn’t make sense” but given what I know and what they don’t know I feel that if I tried hard enough I could actually convince them that they are wrong and could convince them to buy at higher prices thinking they are making a good investment.
The difference is in 2001, all these companies that are raising in the private market were public. The public market had a chance to trade them. Today, only certain people get access. Only certain funds/people/family offices have the assets to take the risk at high valuations-along with the liquidity risk of capital.I’d say that stock trading is also about the big outlier. You can make money by buying indexes and holding. Over time you will do well. But, the way to make big money is assume some alpha and put eggs into one basket-which is what buying a single stock is-assuming more risk than the market.At later stages of VC funded companies, it’s pretty impossible to say “they don’t understand the business”. It’s pretty transparent what Snapchat is, what Uber is, what AirBnB is, what Instacart is. Sure, they may have applications we haven’t thought of yet-but the core business model is there and scaling.
Institutional investors are taking positions in pre-ipo tech because of its low volatility not high.The proposition that high bets stocks offer higher returns is slowly being proven wrong.
The 0% anomaly is pretty new, not since 1000 years (and also probably before), interest rates was that low. They always was around 10%.And now suddenly it’s zero. It’s hard to imagine that they will go up soon. The amount of liquidity is by far outstripping demand.
>> They are full of very sophisticated investors who, I suspect, do understand these businesses very well.Let’s remember our Venn diagramsPublic Investors ∩ Private Investors != ∅As long as there are investors in both markets, the public markets are buying and arbitraging all available information (and doing so better than a less perfect market which comprises *sorry* sheep herded by a few shepherds).The implication is that either Private markets are over-priced or private markets pricing differentials are just sufficient to overcome the cost of public market compliance (probably not tenable).
@fredwilson:disqus – Reply to self {Fred == Shepherd} but occassionally wannabee shepherds get way in front of the flock and fall off cliffs.
Isn’t there another version of this narrative where startup founders/owners, looking out across the marketplace for capital, are just doing the obvious thing and selling where the terms are best?If the “public marketplace” would give you $5/share, and the “private marketplace” will give you $8, and there’s enough capital available at the higher price to accommodate your growth plans… are you supposed to spend time worrying that the guy offering $5 is smarter and understands your business better? Or are you supposed to take the $8 you’re offered and move on?Which is to say, maybe the startups aren’t underestimating the public stock market, maybe the private capital is just overestimating the startups…(edit with a thought experiment: if you are a founder/owner of a startup, and this is how you see the world, what do you tell your investors about your decision not to go public? What do you tell a New York Times reporter?)
YUP
In the past the private markets very rarely let founders take money off the table and so an IPO or a sale were the only real monetization strategies open to founders.This has now changed, and so in this light your comment is spot on.
Yup–that is the story of a chunk of my career.The three IPOs i was involved with were done for just that reason. No other way at that time.
Yeah, that is a HUGE point. Good insight, and one not often mentioned in this discussion as to why founders don’t mind waiting 5 more years to IPO
I agree completely but as I said in my post above, I think this was a way to get Entrepreneurs to do these deals.I think as an Entrepreneur you can sometimes outsmart the finance guys when they are greedy and have a huge FOMO.However, in the decades I’ve been doing this when it comes to money it seems the finance guys almost always win.As an Entrepreneur you are thinking about the business and tons of other things, you don’t do many deals, they are only thinking about one thing every day and do tons of deals.
Premise works when visiting a car dealer. You have all the tools, invoice, price to pay, etc. You do a deal once every five years or more they do it everyday. Who is more likely to win?(Putting your ego aside you usually lose or they make you feel you won, everyone says they got a good deal)
With autos the price depends on many factors, not just the negotiating skill of the buyer. (As I am sure you know) it can be a matter of dealer volume, location, time that you are buying, how much of the salesman’s time you have wasted, quotas to be met and a host of other factors.In any case what is the metric to determine whether the deal is good anyway? What is a “good deal” exactly?
A good deal is what you think you received.What ego maniac tells everyone that the auto dealer just hosed them. The auto dealer enjoys Mr expert car buyer especially when he brings his wife.They do this for a living everyday. If you are not a dealer you will only receive invoice and not factory cost plus manufacturers incentives dealers receive for volume, etc.Lets not even discuss a pre-owned vehicle.You don’t and will never know what the auto dealer stole oh we mean purchased it for.
You are looking for a number.So, iterate:(1) Settle on just the new caryou want.(2) Using on-line data, maybeEdward’s, find a number thatis too low — so low no dealerwill sell it to you for that price.(3) Get a list of dealers, at leasttwo, hopefully several.(4) Take an afternoon off, anddrive to each dealer, and offerto buy the car for the numberyou have in mind.(5) If a dealer accepts your offer,then sign and be done.Else slightly increase yournumber and return to step(4).Worked for me. Some of thedealers, when they saw whatI was doing, got totally torqued,especially as my number startedto converge up to good lowprice. This was for my firstnew car, a nice Firebird, a realhot rod!
Yes, for instance you got the low True Car price!!!!Ooops, well dealers rig that by providing a high trade in value to offset the high price of the car.What do I care if I get $2k more for my trade in and pay $2k more for my car????No difference to me.For the dealer it is an extra $1k in incentive money from manufacturer for selling at list.Yup found that one out.
You know I thought about this more. It is a great comment. If you could not take money off the table you would never do one of these deals. That really says something.
Yup, it completely changes the risk equation for the founders.
It depends if you can grow into (and beyond) the $8 valuation or not.With public markets, you could go down to $3 but then rebound to $15 after you fix a few things. In private markets, if you don’t grow into $8, no one knows what’s really going on, and the next sucker might give you $11 because they are clueless about your business and think they can use a calculator.
Or, if you don’t grow into the $8/share you might have to do a down round (and/or, per pmarca, vaporize).
That would be just one of the terms I am talking about.
There is one big piece you have left out: Terms.I am always on the Entrepreneurs side, but the one thing I have seen over and over is that Entrepreneurs get caught by the terms of a financing.I have heard dozens of Entrepreneurs cry about getting their company “stolen” by VCs. I have talked to so many employees who gleefully calculated the worth of their options only to find them decimated.There are tons of problems with the public markets from SOX to high speed trading, but when you sell a share for $5 You have sold a stock certificate for $5 cash.When you sell a share for $8 to private capital it comes with a 2 inch thick dealbook. I assure you that book is not there to protect you.And yes I totally agree with David that letting founders take money off the table has made a huge change.
Very true Philip.
+ liquidity considerations
Yes and it is liquidity for the previous investors.Its a interesting irony that the terms I am talking about affect the previous investors who also inflicted terms (said tongue in cheek)If you want to see something interesting watch early investors howl at the terms a later investor wants. It is very typical for the last investor to have terms that supersede previous investors.The boot doesn’t feel so good when its not on your foot and somebody else is doing the ass kicking.
Totally this.Farhad mentions “because losses will be confined to venture capitalists and hedge funds that have begun to buy into tech start-ups, as well as tech founders and their employees”Assuming the company is worth more than the cash invested the VCs and Hedge funds are taking no risk by funding these late stage mega valuation rounds.
Exactly the NYTimes doesn’t report you did a raise with a preference, full ratcheting anti-dilution, warrant coverage, and an required exit time-frame. That isn’t interesting.They just breathlessly report a number.
Yep, there is a nice inherent put option built into most late stage funding. (It has value!)
Many of the investors in late stage private are the same as in public markets – mutual funds & hedge funds. 2014 and 2015 YTD data attached. And, because of the terms/preferences, the risk/reward is still favourable for them.”…Furthermore, public investors are measured by total annualized returns relative to benchmarks, not by an investment multiple and IRR. Therefore, what may be an irrational valuation to a venture investor may actually be quite rational to a public investor, especially when contextualized against their overall portfolio.”.http://go.industryventures….Also below is chart from cbinsights which i had attached to one of the comments last week. https://www.cbinsights.com/…Thanks.
With due respect to Farhad and Danielle, I sure hope that this quote is not representative of the sentiments of others founders.It would have been more appropriate to get a quote from a company who is already in the stratospheric levels of private valuations.
Agree, that quote made me cringe and I hope it isn’t representative….but I’m not sure they would comment at the top end – it seems to me there’s a tension between playing the game vs. providing value. I’d love to believe that Uber is completely focused on doing the latter but it just doesn’t seem that way and I can’t think of a single reason they’d want to talk openly about the fact that they are billions in already and still not revenue positive. The stakes are too high now for that.
Well, if the money is used to grow the business, then that’s great. But at some point in time, the business needs to grow into the valuation. In reality, some will, and some won’t. The private market funders don’t have a better crystal ball. They are placing bets.
It appears when companies are valued similar to Uber the risks and the real time challenges that are directly effecting the business model is not accounted in any revised valuations.
The biggest difference between private and public markets is that the shorts have a voice and are not afraid to be heard in the public markets.
1) Fred hit the nail on the head. “Don’t understand my business” = time horizon preferences are different2) Everyone focuses on late stage number (I.e., valuation). Still do not believe those writing about it are focusing enough on terms. Reminds me a bit of NFL contracts: there is the number a player’s agent puts out to say how good a job he did, but then there is the real value of the contract as determined by guaranteed money and leverage points at different times through the lifetime of the contract.
Right. And another benefit of the public market (for both investor and investee) is that there are far fewer classes of shares that have different terms. So this aspect of shareholder management becomes simpler. You just don’t have to think about it as much.
It is interesting to compare with the Chinese public markets, which could be said to be relying on the so-called “unwashed masses”. Given the recent behaviour of the Shanghai and Shenzhen stock markets, I think it would be hard to argue that the China is full of very sophisticated investors. In fact, the “greater fool” mentality that prevailed recently suggests that the local investors disagree too. This is evidenced by dramatic price surges driven by simple company name changes. Despite this, the extreme volatility has made for a roller coaster ride that has drawn overseas-listed Chinese companies back to China in search of crazy valuations. So perhaps it has its advantages too?
Having spent 10 years on Wall Street and gone though many valuations of both public and private cos I agree that it is arrogant for founders to say that Wall Street does not understand startups. There are not 1000 ways of valuing a company, there are a few and to base a valuation purely on growth rates and market share is not one of them on Wall Street while it is one of the prevalent ones in VC land. My view is that startup founders need to realize that burn rates, expenses, negative EBITDA, negative net income do matter and revenues are not the only thing that we should focus on.
There are not 1000 ways of valuing a company, there are a few and to base a valuation purely on growth rates and market share is not one of them on Wall Street while it is one of the prevalent ones in VC landAgree. A good way to snooker someone is to make up a new way of looking at things and tell them that they just don’t understand. In order to make that happen it’s much easier if the group that you are talking to already has bought into the new way rather than are skeptics even if your explanation doesn’t make any logical sense. Anytime you can successfully point to “the way it’s done” there is a group of people who will not think any further or want to appear stupid by asking any questions. Social proof at work business technique used in many areas.
My company was acquired by a small-cap public co that was in a highly competitive and slow-growing market. Every qtr they reported some non-GAAP numbers that were s’posed to better reflect the business than the reported GAAP financials. This isn’t uncommon but my point is when the business isn’t great non-GAAP numbers are just as crappy as the GAAP ones.
As a founder, you have a choice: Growing into a mature and respected company slowly but surely, or be lured by private market vultures who are clueless about your business.The other thing that gives with successive private valuations is you’re not providing liquidity to your employees or previous investors. So is it really a private IPO, or just another evaluation inflation?
But offered a pile of money and you work the same or a pile of money and you will have to work much harder, what do people go for?
yes i agree and you are correct. I’m a patient builder of stuff by nature as are you.but no, it’s not that simple for entrepreneurs as you know.the lure is not greed, the lure is the freakin crazy process of always being under capitalized and always raising capital.a process that has little to do with building a business.lean as a approach for all of its goodness, has a dark side and it drives this in my opinion.being perpetually capital poor is like always being needy. always being closing time. it drives poor decisions, drives lack of patience and now getting a lot of attention as it should–exacerbates mental duress.
Not making a profit drives this problem. If startups focused on generating profits they wouldn’t have to rely on raising money to pay expenses.
Well, if the public markets don’t understand your business, the private markets are sure to be clueless about it, if they are paying at the stratospheric valuation levels they currently are.
I would like to see an anatomy dissection of a private markets financing, say $200M on a $5 Billion valuation. Where is the $200M going, and how did they arrive at the $5B valuation?Any founder will get drunk or high on a few million dollars, but I’d like know what the drug dealers are telling them.
A simple thought from the commonsense sector. Can the companies that have the valuations some are yelling that are inaccurate sustain a major market correction no fault of their own? An entire sector being hit because of news on a similar company. (The infamous tech bubble and crash).
What an unfortunate choice of words. While Wall Street can certainly be accused of being driven by short-term, quarters-oriented results, Silicon Valley can just as easily be accused of being driven by middle- and upper-class groupthink. Very large businesses need to appeal to those “unwashed masses” in order to substantiate billion dollar valuations; perhaps when the “unwashed masses” don’t understand a business well enough to feel comfortable investing in it via the public markets, they also don’t understand it well enough to use it as customers.
The big difference is that in the private market you get to choose who your shareholders are, and you can choose the ones who have the same vision as you. On the other hand on the public markets you not only don’t get to choose who your shareholders are but also have to deal with non-shareholders shorting your company.The huge risk of not going public is getting lost in a confirmation bias loop with your handpicked shareholders and miss something huge that the public market would certainly point you to.Amazon is a great example of a public company who is managing to keep focus on the long term and selling this vision to the public market. Of course they have to deal with naysayers from time to time, but I’m certain that they end up helping Bezos refine his strategies.
The human memory span is short. The room for intentional misinformation by Analysts would always give us pause in accepting (edited word) what is being pushed by companies being paid for an opinion. Both private and public valuations have an interest in the numbers fitting a certain narrative.When the herd of Analysts give valuations we recheck the numbers out of a lack of confidence from previous incorrect valuations and fraud.When fraud was uncovered in Salomon Smith Barney Analyst case everyone appeared shocked.http://youtu.be/SjbPi00k_ME
The world is rife with similar “shock” such as in this case today where the owners of a cash business “The Bangles” (not the musical group) pleads guilty to tax evasion:http://www.philly.com/phill…Good thing most cash businesses don’t do the same.
The really interesting thing is that public and private markets are both ultimately funded by the same institutional sources, only run through different filters. If/when those sources will think to revisit the filters is the question, and what would cause that to happen.
There are 678 companies with $100M or more in VC funding who need to hear this warning!Personally, I am happy Twilio has taken this much funding in the private market and I think it would have been super difficult for them to explain what they do to a very broad audience of public market investors (I was hard enough explaining it to developers at first!).There are a lot of businesses where it makes sense to build as much value, brand, etc. as possible first before going public even when you are a totally amazing company solving a big problem. Investors are really not as sophisticated as you are hinting, they are very dependent on analysts and analysts still don’t do a great job covering SaaS, let alone PaaS. This is true in both public and private markets, but in public markets you have to deal with a much higher volume of investors who you need to educate.
Nice to see you here commenting! I know (or assume) your data doesn’t go too far back beyond your company forming, but I would bet say 10 years ago the number of companies who had received $100M or more was probably less than 100. Besides the dot com hysteria we have averaged I believe about 50-60 tech IPOs a year, which sort of aligns with the number of $100M type fundings that there likely were. There is no way tht the markets can handle 700 IPOs (or even 300 etc). Having worked as an equity research analyst at an investment bank for a summer I know how hard it is to get coverage on really any company under $1 billion, and often under $5 billion. I think the takeaway is that the private IPO is really a replacement for what would have been more M&A deals at substantially lower valuations a decade ago. I think that is a large piece of this, the more I think about this.
Yes I have to believe you are right, I don’t think the number of companies getting $100M or more in funding has ever been as high as it is today. Even in the Dot Com boom and run-up to the crash (1995 onward?) I don’t think companies were raising this much money before going public very often.I feel like there are a lot of companies with cash on the balance sheet who could buy these startups, but they probably think they are overpriced. Afterall, the time horizon for a cash rich company is forever. They can just wait until there is no more funding left for the startups and then get more pricing leverage. It’s a really interesting aspect to things.
Just to be clear, what is the exact warning?I don’t think the pushback was about *not* taking private markets funding. The question is – at what valuation? And is it reasonable or super-inflated? Will these companies grow into it or not? Are they really continuing to fund their growth, or just being greedy? How does it affect their (eventual) public markets entry? And how are they taking care of liquidity options for employees, founders and prior investors?On these 678 companies with $100M, is there further analysis depicting their age, revenues, valuations, and survey them asking them if they plan to go public or not. How many are “really” ready to go public? I’m not sure if there is a straight correlation between “money raised” and “readiness and maturity”. Maybe there is for the top 10% of them, but the problem I see is that some startups look at the very top / best, and they automatically assume that anyone can do what Facebook, UBER or Airbnb are doing. Trick is these top companies are a tough act to follow for the most part.
I read the warning as “don’t buy into the idea that your private market valuation will necessarily hold up in the public market, because the public market is sophisticated and will price you in a meaningful way”.RE: analysis. Sounds like another blog post is in order!
Yes, to more analysis! You’ve got the data 😉
Believing in yourself is mandatory.Not realizing the massive difficulty of doing what those three accomplished is a true mark of ignorance or monumental denial–in either case-not someone I would back.
“Investors are really not as sophisticated as you are hinting”Actually they are. They just use classical methods of valuing an enterprise rather than the more fragile methods used in private tech. Different does mean dumber.
Are classical valuation methods the most applicable though? And I’m certainly not suggesting otherwise, just might be worth exploring if you could miss more winners in the tech space using classical methods to evaluate them.
“If you can get $200 million from private sources, then yeah, I don’t want my company under the scrutiny of the unwashed masses who don’t understand my business,” said Danielle Morrill, the chief executive of Mattermark, a start-up that organizes and sells information about the start-up market. “That’s actually terrifying to me.”For those that aren’t aware, the full quote indicates that it comes from Danielle Morrill of Mattermark whose is just talking her game and whose business model depends on, and is built on, giving investors an edge in the current bubble market.Hopefully Danielle is thinking ahead as she signs leases for office space and takes on additional overhead. And she realizes that 2 years in business when everything is going up, up up, may very well not be a sustainable business model. To me, that’s terrifying. I’d be waking up every morning trying to diversify into other areas or working to unload the puppy before the tide goes out.
Everyone talks their book. Fred would prefer that highly valued portfolio companies just go public already and let the market value them, and I don’t blame him!As to my company, of course I think about how to diversify Mattermark’s customer base constantly — as the base of private investors who pay for research is limited to about $10-20M a year. Only 30% of our new revenue came from investors in Q2 and we have been expanding into other verticals since the beginning of the year.I don’t plan to “unload this puppy” I plan to get profitable and make a lot of money solving a lot of problems for customers. Our business may well be counter-cyclical, helping sales teams be more lean and M&A teams find targets more easily. Time will tell.
Not a dig and kudos for the NYT print edition mention “above the fold?” or at least in the opening paragraphs. [1]I think about how to diversify constantly as the base of private investors who pay for research is limited to about $10-20M a year. The info that you compile is interesting to me (I am not your target market at all) however at $500 per month price point and/or even with a free trial it’s a non-starter. Not because I don’t have $500 to spend but at that level it’s simply to out of bounds to take a flyer expecting that my theory of what I could do with your data would work for me. It’s not an impulse buy it’s a commitment. It’s not a definitely need it’s a “might be helpful”.[1] Have been known to say things to get into print (successfully) knowing full well what a reporter will think is interesting to repeat, irregardless of whether it was highly accurate or not. It was accurate enough to provoke thought and sell papers and gain publicity. Thinking in advance of just the right words that the reporter will find interesting. [2] However I am certain that every single other person who has ever been quoted in any paper certainly has not done that.[2] “Unwashed masses” and “terrifying” worked well in that quote, right?
Thanks. Danielle. Like your thoughts. I’ve long felt that the private market, especially when you have VC’s like USV and Foundry Group participating in seeds stages and leading a round, is preferable to having a board and team too focused on fluctuations in public market valuation. I realize this isn’t always the best long term funding option for many startups depending on numerous factors.Just signed up for your email. Looking forward to learning more.
Do your customer’s “problems” include better insight of the risks and rewards in the weeds of IP landscape?
“Pride comes before the fall.” Ain’t that a truism…
There has always been and always will be a dissonance gap between private and public market valuations and the terms founder(s) find themselves with.Institutional investors have specialized training in how to value companies.This is not to say that they understand the value from an active user perspective. However, they do likely understand the business from a pure accounting and unit economics perspective.It’s important for founder to be open to being educated by public market investors as much as being buffered and patronaged by private investors.
My understanding is that early stage investors (angels and VCs) normally realize gains (or losses) upon an exit usually in the form of an acquisition or a public market IPO.I am curious if and how frequently early stage investors have been able to realize gains in the emergent “private IPO” market?
I love you Fred. I know we’ve had our disagreements in the past, but I love you. Not every company should be valued based on hope and the latest round of greater fools. GS is hated by many in SV, but GS ain’t stupid. I know this isn’t what you’re trying to say, but felt like an appropriate time for me to say it. You’re very wise Fred, exactly what your industry needs right now.
Great post Fred. You must be an expert re: understanding how founders change over time as they raise large sums of capital, hire huge teams and start believing that their rising star will never fall. It must be really painful to watch at times.
A long time friend of mine is a senior officer in a very exciting biotech company that went public recently. The company is science heavy and the personnel are incredibly highly educated with many having decades of experience. I recently heard a webcast for analysts. It was extremely technical and I was very impressed by the depth of scientific background of the analysts asking the questions. These guys had really done their homework. It’s their job to understand these businesses and they take their job seriously. Their conclusions can result in major investments and this responsibility is real. So I completely agree that Wall Street should not be looked down on in this manner.
Fred, I agree with you. But this Danielle Morrill person (you quoted her above) is a savant with marketing.She needs to temper the insecurity and arrogance, no question, that’s a given. But you just don’t see strengths of that caliber every day.She made the NYT article sound like it was written for her company Mattermark alone. Now there is an AVC post dedicated to her words alone. If I were a VC, I would take a very close look.
How about the role of Board Members in this? I haven’t heard of a recent case where a board member resigned because they didn’t agree with the irrational valuations of these private financing rounds.
The duty of the board is to increase shareholder value, i.e. valuations
but also to warn against doing foolish and risky things.
Companies may also be wary of dealing with activists like Icahn if they go IPO. This is an an important that hasn’t been discussed in the NYT article or here.
Leaving e hypothetical, Etsy is one data point showing the difference in valuations between late stage private money and the public market. Twitter too as one of the first big late-stage deals.
For But I think tech sector ismaking a huge mistake in thinking thatthey know their companies and how to valuethem better than Wall Street. That kindof thinking is arrogance and pride comesbefore the fall. sure, for a private company UGE, maybeWall Street is plenty good at knowing whatevaluation Wall Street would put oncompany UGE if Wall Street did an IPO forUGE. Right: If we think of the “value”of a company in terms of what value WallStreet would put on the company at an IPO,then, sure, almost as just a tautology,Wall Street knows its own mind, that is,what Wall Street thinks.Further, if we regard “the tech sector” asits investors, VCs and recently PE, then,sure, again, Wall Street should know aboutas well as the VC, especially the PE,investors what value Wall Street would puton the company if Wall Street brought thecompany public.On the other hand, of course to buy acompany is to believe that the value, insome relevant sense, what the offeringprice would be at IPO, what the netpresent value of the discounted futurecash flows, etc., of the company willincrease significantly in the future. So,we’re talking the future.So, a private company, in particular, it’smanagement team, really should know muchmore about the future of the company thanWall Street. Or in Wall Street and SECterms, the management team is awash inmaterial inside information — generallyregarded as so valuable that it’sdisclosure is very carefully regulated bythe SEC.So, Fred’s quote seems to claim that theinside information is never valuable.But in some cases, inside information,especially for tech and bio-tech, shouldbe very valuable in which case themanagement team should know much moreabout the future value of the company thanWall Street.
The misconception is that public market investors are less savvy than private market investors. At the end of the day, if your business is clearly able to articulate profits being spent on growth that accrues to the underlying book value (beyond the cost of operations) or profits being given back to shareholders because book value can’t be expanded investors of any sort will ‘get’ your business.If you’re growth prospects, operational expenditures, and shareholder value are too complicated or unnecessary than why in the world would the public markets look at your business? There are hundreds of other businesses who aren’t unnecessarily complex for them to invest in.VCs have a role in this as well, there are many who over-complicate the capital structure with unfounded expectations and off the wall scenarios that most investors can be profitable without dealing with. Simple capital structures that fit within the current norms of the investor community are just as important as products that fit within the norms of your customer’s community.
>At the end of the day, if your business is clearly able to articulate profits being spent on growth that accrues to the underlying book value (beyond the cost of operations) or profits being given back to shareholders because book value can’t be expanded investors of any sort will ‘get’ your business.Well said.
baloney. private investors motivated by fear of missing a great IPO so happy to buy. public co investors don’t want to be outside the tent when insiders are bailing so usually do not encourage insiders from selling until the story becomes achieved. the pre-public deal gives insiders best of both worlds from a far more forgiving audience and so a deal gets done before the public folks have to be placated.
Good point. There are many reasons to stay private but this is not one of them. Interesting that the private funding trend is running in parallel with a culture of “transparency” among many tech companies. Public markets are about transparency so there is no reason to be afraid of them.
Yeah, right…http://www.bloomberg.com/ap…
Amen brother Fred
I say bravo Danielle for having the courage to take the risk of starting a business. If you start out thinking you’re going to fail, what’s the point? It does not negate the realities of the market about your business.
I am not sure “what a liquid market is willing to pay” is the true value of a thing, but it is the best approximation we have found. (Use value vs exchange value was a concept covered briefly in microeconomics 101 and then never seen again.)
I don’t think it makes much difference to option holders whether they cash out in a private round or IPO/sale. A more delicate point is whether the private investors actually extend the offer to them. As JLM often points out: either everybody or nobody should go to the pay window.
In notional amount yes, but not percentage. Facebook has gone from around $100 B to 220B I think. So yeah 60% ($120 B) has come since going public, but its “only” a 120% return. In the past facebook would have gone public at 5-20 billion and wold have been a 2000% or 1000% return. That is what they mean, the amount of return by percent/multiple of initial investment
Understood. If that’s what they meant, then I agree. But the wording suggests that most of the “biggest gains have already been extracted” meaning there is less upside going forward which I don’t necessarily agree. I think your original point of 60% is what they were referring to and that just proves most of the value can still come post IPO.