The number of Unicorns has exploded from 2013 to 2015, reaching 140 members. This represents a huge growth spurt for valuations and reflects a positive attitude towards the venture industry.
After a turbulent 2016, which saw scandals, funding cuts, and a more cautious investor commentary, many people have begun to question the value of the sector. In this context, 2017 will be a year of make-or-break for the Unicorn Club. Is it over?
After several years of bubbly fun, 2016 was a year that marked a change in tone for the notorious Unicorn Club. The scandals were first.
Theranos was engulfed in controversy as it lost clients, faced regulatory scrutiny, became embroiled with shocking revelations by former employees, and fell from grace. Theranos, once worth $9 billion, is likely to go out of business soon.
Zenefits was made to admit by another famous Unicorn. Parker Conrad, the co-founder and CEO of Zenefits, actively promoted practices to allow Zenefits’ sales agents to avoid compliance training in California. Parker Conrad resigned, and the company’s value was reduced from $4.5 billion in June to $2 billion.
There are many more Unicorns that have been affected by scandalous revelations, including Lending Club and Hampton Creek. While scandals may sell newspapers (or, in the age of online advertising, ads on websites), the most troubling thing is that they all fed the critics.
The discovery of fraudulent behavior at Unicorns only added to the doubts that already existed about tech sector valuations.
In general, 2016 was a year of reality checks for the tech industry. Chamath Palihapitiya of Social Capital said, “There’s a bunch of businesses that are good but not great. But they have raised money like they are great.”
The data seem to confirm this. Charts 1 and 2 demonstrate that the rate of Unicorn births has slowed significantly. More troubling is the fact that 2016 saw an increase in the number of downrounds for the Unicorn Basket (see charts 3 & 4). This trend has been evident since 2015 but has gone unnoticed due to all the good news.
The Unicorn Club, as a symbol, was also under pressure, just like the entire technology and startup sector. Arguments from the naysayers gained momentum, prompting serious concerns about the future of the venture capital sector.
What is it then?
There are positive signs in the industry for 2017. The forces that made 2016 such a difficult year are now reversing, and the factors supporting the rise in valuations of the past few years do not seem to have diminished.
The Return of the Tech IPO
In the first eight-month period of 2016, there was only one venture-backed technology company listed in the public markets. In spite of a slight increase in the second half of 2016, 2016 ended as the worst year for technology IPOs since the financial crisis (see Graph 5).
The performance of those who were already in the public eye was not encouraging.
Twitter, Fitbit Box, Etsy, and other legacy 2014-2015 technology listings saw their stock price fall in the public market. Some of them reached prices less than half of their IPO prices.
This phenomenon is due to a number of factors, but all of them are related to the huge amounts of capital that investors have locked up in private venture funds.
Venture funds, boosted by their growing balance sheets, poured money into technology startups in the five-to-seven years prior, thereby supporting the high valuations that many were criticizing.
In addition to this, many investors who would previously have invested in the public markets are now moving to private markets to try to get higher returns. This includes mutual funds, Hedge funds, and sovereign funds.
Bill Gurley, the General Partner at Benchmark, commented: “With interest rates this low, people are looking for yield, and money is sloshed around.”
It is not surprising that many companies avoid the public market in this context.
It seems natural that, when faced with the prospect of going public at steep discounts and the increased reporting requirements, as well as the greater transparency required for their operation, a CEO will continue to rely on the private market for liquidity.
There are signs that 2017 could be different.
Union Square Advisors, an investment bank, estimates that as many as 90 companies may be looking to go public in the coming year. Morgan Stanley’s technology banker predicts that 30 to 40 technology companies will go public this year.
Snapchat is the most well-known example, and it’s arguably been the most anticipated tech IPO in recent years.
Snap, Snapchat’s parent, is worth $18 billion based on its latest investment round. If reports are to be believed, then Snap’s IPO will likely fetch it an additional $4 billion at a valuation of $25 billion. This would make it the largest U.S. tech company IPO since Facebook in June 2012.
Snap’s IPO is a key listing that will set the tone of the year.
What is behind this shift in sentiment?
No doubt, 2016’s “reality check” has led to a revaluation of many technology companies, which has helped ease public market investors’ fears.
The more challenging funding environment in 2016 put no doubt pressure on companies to refocus their metrics and fundamentals to avoid having to access public markets in the future.
We can predict that if 2016 wwerea year of culling, the companies left would be the healthiest.
While a Trump presidency will continue to cause uncertainty, its short-term impact on the stock market is largely positive. Stock prices have risen, and investors are returning to a “risk-on attitude.”
We’ll see. The IPO queue is growing, so it’s not surprising that if things start well in the new year and Snap IPO performs well, then the floodgates could open.