Ahead of the Covid-19 pandemic, IPOs for many startups with supposedly bright stocks fell when they entered the public sector. Some didn’t make it that far, canceling in 2019 their public offerings. A troubling gap between the general public and private valuations of venture-capital-funded start-ups has surfaced. This divergence will most likely continue because most start-ups are remaining confidential for longer periods.
Why the Gap?
Valuations of private companies are speculative. It had been that start-ups received no more than three rounds of VC funding and were acquired or became individuals within five years of commencing business. Now it’s not uncommon for start-ups to receive six rounds of funding and keep personal for over ten years.
As a startup grows to a mature business, both its revenues and expenses increase, exposing it to a different economic environment. More challenges emerge — further competition, saturated markets, acquiring customers. Venture capital firms, who profit when their startups exit, have shown remarkable patience.
Valuations of private companies are speculative.
Benefits of Being Personal
A considerable benefit of being private is a company does not need to disclose financial information. As a startup’s market evolves, more competitions jump in, and each company needs to spend more on advertising and client acquisition. Often this means that the startup requires more cash.
So we are currently seeing Series E, F, and G funding rounds. With each round the test increases. When the press covers unicorn start-ups (valued at more than $1 billion), it focuses on what the start-ups and the VCs disclose — an increase in sales, customers, and valuation. Regrettably, ballooning advertising costs and absence of gains are not discussed, making for a one-sided and often false image of a business’s actual problems. All the hype ends, however, when the company files to be a public thing.
Fred Wilson, co-founder of Union Square Ventures, a venture capital firm, wrote in his blog,”. . .valuations in the private markets, notably the late-stage private markets, can sometimes be irrational. Public market valuations, certainly after a stock has traded for a material amount of time and lockups have come off, are a great deal more rational.”
Valuing a Start-up
A startup’s evaluation is whatever engaging traders believe that the thing could be worth. When it is set up, a startup is looking for angel or seed investments. Without earnings, investors often apply a scorecard to appreciate it. Factors include:
- Experience of the founders,
- Competitive environment,
- The company or market,
- Opportunity size,
- the product and its possible requirement.
Should they think the startup has a good team and other competitive advantages, the angel investors will assign a higher, subjective valuation.
VCs often utilize a cash-flow variant to assign a startup’s value. Discounting projected cash flow to the recent admits that the time value of money and determines the VC’s percentage of ownership. There are pre- and post-money valuations — the latter coming after the angel investments. Those initial investors seek a maximum valuation and thus endure and promote hype.
Determined by the participants that stand to make profits from a significant evaluation is an inherent flaw in the startup system.
VCs value start-ups in technology areas considerably more than other industries. Hence many start-ups have been calling themselves technician providers however tenuous the connection. Uber and Lyft, which supply taxi-like services, call themselves tech companies because customers use an app to summon rides. Both are losing considerable amounts of money and have not shown a path to maturity.
VCs value start-ups in technology areas considerably over other companies.
Uber went public in May 2019 at $45 a share using a valuation of $75.5 billion. It closed at $26.39 per share on March 24 with a market cap of $45.5 billion. Lyft went public in March 2019 at $72 a share with a market cap of $24 billion. It closed on March 24 at $27.06 a share with a market capitalization of $8.3 billion. While the share prices of both these firms are more vulnerable to Covid-19, on January 2, 2020 — before the pandemic — Uber’s share price was $30.99 and Lyft’s was $43.58, still well below their initial pricing.
Uber went public in May 2019 at $45 per share. Its stock price has declined since then. Picture: Yahoo Finance.
Casper, the mattress-in-a-box company whose IPO I covered earlier this year, also promised to be a technology provider. It called itself a”pioneer of the sleep industry.” Casper went public at $12 a share, under the 17 expected price. Analysts recommended that nobody buy the inventory. On March 24 it closed at $3.77 a share with a market cap of $149.6 million, only 13.6 percent of its personal valuation.
WeWork, a”property for a service” company, also characterized itself as a technology company. It said it was”changing the world” by renting co-working space. Investors gave WeWork a $47 billion valuation even though public companies with precisely the same business model traded at substantially reduced sales multiples.
IWG Plc, a competing flexible office space provider, had a market cap of $2.9 billion, approximately one-tenth WeWork’s test, despite having 3,000 areas compared to WeWork’s 550.
In August 2019, WeWork enrolled its S-1 (IPO registration) with the U.S. Securities and Exchange Commission. In the end, its financial statements were offered to the general public. It had been that WeWork was shedding loads of money. In 2018 the company lost $1.9 billion on $1.8 billion in revenue. The financial press releases. The Wall Street Journal, which in 2017 published an article entitled”WeWork: A $20 Billion Start-up Fueled by Silicon Valley Pixie Dust,” composed on the day of the filing that the company might want to reduce its valuation to draw attention. Rett Wallace, CEO of analyst firm Triton Research, called the filing a “masterpiece of obfuscation.”
Thirty-three days after it was filed, the offering was canceled. WeWork’s evaluation decreased by 70 percent, and Adam Neumann, its CEO, was fired. The bankers who priced and managed the IPO, JPMorgan Chase and Goldman Sachs, together with initial shareholders, were amazed. They had anticipated a market cap ranging from $63 billion to $96 billion.
Japanese technology firm SoftBank, WeWork’s primary investor, decided to bail out the company by buying $3 billion in extra stock. Earlier this month, SoftBank advised WeWork it could withdraw from the arrangement in the wake of government inquiries into WeWork.
VCs are imposing tougher terms for late-stage funding and procuring protections of the initial investments in unicorns. But many VCs are not tamping down the hype. Instead, they wait to see that the gains from public offerings that are forthcoming.
The effect of the coronavirus on personal business will most likely be limited because it is the sum invested that determines the value. Thus VC-funded ecommerce merchants will probably not see much of a bump for precisely the same reason, even if their earnings grow.
For public companies, the situation differs. Ecommerce merchants which sell consumer goods, groceries, and health products are seeing an increase in earnings and a bulge in stock value. Public video-conferencing companies have seen significant gains in their share prices. Zoom Video Communications, which went public in April 2019, saw its share price rise from $76.30 on January 31, before the pandemic to $138.11 on March 25. The Zoom app became the most downloaded mobile app for iPhones past week. Its completely free version is easy to use, and its subscription version is currently the most popular video-conferencing tool for remote workers.
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