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This is the third part in our series on SaaS valuations and IPOs. Read the other two posts in the series about the 2016 venture outlook and understanding SaaS Valuations.

The summer of 2015 was a hot one. Not just in terms of temperature (although it was that, too), but also in regard to the climate of tech funding. Throughout the summer, VC experts and tech market mavens got all lathered up about the unprecedented amount of private dollars flowing into young startups.  

An August article from the San Jose Mercury News perfectly channels the excitement. “It’s a fine time to be a tech entrepreneur,” the news source gushed. “Investors are funding companies at record pace, writing checks ‒ big, big checks ‒ to startups large and small that are creating everything from business software to cures for crippling diseases.”

And the numbers bear out this assessment: Q2 2015 was the single biggest quarter for VC investments in Silicon Valley since that previous scorcher, the second quarter of 2000, the news source reported.

The enthusiasm seemed to reach fever pitch in the waning months of summer, as many investors practically tripped over one another to cut checks to bullish SaaS founders.

“The returns on investment [in software] are just too healthy to ignore for people who want to put cash into the market,” Mark McCaffrey, a software industry expert with PricewaterhouseCoopers told the news source.

Top 5 2015 Funding Rounds

AirBnB: 1500 million dollars
Zenefits: 500 million dollars
DocuSign: 278 million dollars
Denali Therapeutics 217 million dollars
Aduro Biotech 200 million dollars

But the story is not all unicorns and roses. If you’re beginning to feel like all of this sounds suspiciously like a pop-prone bubble, you’re not alone.

Big-Check

Many venture capitalists and market-trackers anticipate that the unbridled optimism in the private investment world is about to get a course correction.

Indeed, most of these experts believe that the course correction will occur in a very prominent (and dangerous) place: the IPO.

What’s Happening to the Tech IPO?

A Herd of Dead Unicorns

According to many important startup experts, this turnaround has already started.

Bill Gurley is one of them. Gurley, the famous investor behind Uber and Snapchat, made waves this summer when he said that “the complete absence of fear” in Silicon Valley is likely to result in a painful period where some tech darlings experience an ugly IPO, or worse.

“I do think you’ll see some dead unicorns this year,” Gurley told Fortune.

I do think you’ll see some dead unicorns this year.”

According to Gurley and others, the prominent success stories of famous tech startups are causing investors to lose sight of the precepts that urge them to temper optimism with prudence. There are so many tech companies that, even though they have yet to earn a cent of profit, are receiving huge influxes of VC dollars. Many experts say there is no way this trend can continue.

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Famous Investor Bill Gurley. (Source: Wall Street Journal)

And, as is so often the case, the scorching climate of summer appears to be giving way to the chillier realities of autumn.

A Tale of Two Markets

Historically, whenever the private market becomes overheated, the public market is not far behind to cool it down. It happened in 1987 when investors became enamored with trendy but unproven companies. And, of course, it happened in 2000 with the first dot-com bubble, when growth-hungry but not-yet profitable companies hit the market.

Early indicators from this fall suggest that a similar trend may be shaping up, although one that is hopefully not so far-reaching.

A recent article from The New York Times spells out how the public market is responding to the flood of young tech companies filing. According to the news source, the IPO market is at a several-year low. And there have already been several instances where private-market poster children have been met with IPOs well below their private valuations.

Why is there such a gulf between the private and public markets right now?

According to a recent article from Fortune, one reason is because “it’s becoming increasingly clear that not all [unicorns] will complete the journey [to profitability].” Tech startups that received hundreds of millions in VC funds haven’t always made it big enough to return the favor, and the public market is likely a lot less forgiving than flush VCs in this regard.

Where private investors are willing to place large bets on unproven companies, public markets are far less eager to do so. This means that some promising tech startups ‒ yes, even those heralded unicorns ‒ may be greeted by an IPO that doesn’t equal their last valuation or, worse, they may not IPO at all.

“The proverbial IPO window is not open for all of these companies,” Anand Sanwal, CEO of CBInsights, told the outlet. “The fundamentals of many of these companies are far from proven. They would get chewed up in the IPO market right now.”

What Goes Into an IPO?

This last quote raises some important questions. What affects an IPO? What “fundamentals” would cause these companies to get chewed up? If there is a different measure of success for a company that receives a sky-high valuation in the private sector than there is on Wall Street, what comprises this difference?

The short answer is that venture capitalists are more willing to place bets based on potential and user-base growth than their public-market counterparts.

Take Dropbox. In most ways, the online-storage software company is a perfect example of a SaaS success story. It grew rapidly, expanded its offerings, and attracted all the right investors. And yet…there are serious concerns about its public potential.

Last year, Dropbox scored a massive $250 million funding round, valuing the company at $10 billion, according to TechCrunch. But after that blustery round of funding (actually its second $250 million round), sentiments about the company’s IPO potential have soured.

According to Zero Hedge, investment bankers are worried that Dropbox will not be able to go public at its $10 million valuation. In fact, BlackRock, one of the VCs that spearheaded Dropbox’s huge round, has since cut its estimate of the company’s per-share value by 24%.

This value-gouging hasn’t gone unnoticed. A few days ago, The Wall Street Journal chimed in: “The data suggest that even some of the most promising startups in Silicon Valley might be worth far less in the eyes of the rest of the investment world. The risk is that the lackluster reception for tech startups in the stock market could ricochet through companies that are still private.”

And Dropbox isn’t the only tech unicorn to face some unexpected headwinds when it came time to IPO. A few weeks ago, we wrote about how Square came under serious scrutiny when it filed its prospectus to go public.

“Like most startups, Square is incurring a larger amount of operating expenses,” The Motley Fool reported. These expenses ‒ especially in light of the fact that Square is still losing money ‒ have prompted some serious concerns about how promising-but-unprofitable companies can expect to fare when they dip their toes in the IPO waters.

And this all raises the next logical question: What can tech startups learn from the chilling climate for IPOs?

Lessons From Past, Present and Future Unicorns

Square and Dropbox (and all the other recent worrisome tech IPOs) hold some important lessons for venture-backed SaaS companies thinking about their futures.

The most important lesson is also the simplest: raising tons of cash, and burning through it, may not be the wisest move. This may sound obvious, but it actually flies in the face of conventional wisdom, which has often argued for young startups to spend a lot of money to give them the best chance to achieve exit velocity.

But, lately, people have started asking a new question: exit to what? Securing market share and dominating your segment is great, but only if the math that has gotten you there points in the direction of profitability. And, as so many unicorns are now demonstrating, this isn’t always the case.

As a result, cash burn for private companies has become a hot topic.

Legendary investor Marc Andreessen recently raised the cash-burn alarm. He posted a series of widely circulated tweets that argued on behalf of a much more serious level of financial restraint.

“High cash burn rates are dangerous in several ways beyond the obvious increased risk of running out of cash. Hire burn rates kills your ability to adapt as you learn & as market changes.”

In the series of tweets, he goes on to say that high cash burn incentivizes rapid (and perhaps reckless) hiring, often leads to bloat and poor management principles, and a fake feeling of “we’ve made it!” without the pressure to deliver real results.

So what is Andreessen arguing for? Essentially, he’s making the case that VC-backed startups need to be better about “living within their means.”

Measuring (and projecting) unit economics, minimizing cash burn, prioritizing customer retention just as much as revenue growth ‒ these are all ways growing companies can minimize their risk of finally making it to an IPO, only to be very disappointed.

When private funding is abundant, it’s easy for growing tech companies to take as much as they can get and hope for the best. But a recent splash of cold water from a less bullish public market has reminded us what we should have known all along: ultimately, a company’s ability to turn a profit is what investors are looking for.

Mike Baker
Mike Baker is the Content Strategy Manager at InsightSquared, where he helps distribute original eBooks, articles and guides about data-driven sales and marketing. He has a BA in English and Journalism from Oberlin College.
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