It’s clear that public markets don’t always share Silicon Valley’s sunny optimism at IPO time.
One recent and much-discussed example is flash data storage company Pure Storage, which raised $425 million in its highly anticipated IPO but then fell back to earth on the first day of trading, when the stock closed almost six percent below the IPO price. San Francisco-based Square priced its IPO shares at values about 40 percent lower than its last private funding round.
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It would be a mistake to view this as merely a unicorn problem, though – an issue that only affects tech startups valued at $1 billion or more based on venture capital faith alone.
The story of those two companies’ IPO woes takes place in a venture financed environment marked by overly optimistic business plans and private valuations featuring revenue projections that rarely come to fruition. American IPOs fell to a seven-year low in 2015, prompting many to wonder if another tech bubble is on the horizon that will wreak widespread economic havoc.
Maybe it’s a market correction instead — and one that has the potential to ultimately improve the environment for investors, companies and customers alike.
The truth is that the way we’ve been funding and growing tech companies doesn’t make much sense.
Lately, it’s far too common for entrepreneurs who are seeking funding to inflate projections using the infamous “hockey stick” chart: That’s what most venture capital firms expect, and company leaders who would rather submit more accurate plans are afraid they won’t be considered for funding if they paint a more realistic picture.
So what happens when startups get a huge infusion of cash based on unrealistic projections? The pressure to generate returns right now increases exponentially.
That can lead to many problems, including burnout, excessive risk-taking, and mistakes, all of which have the potential to waste tens of millions of investor dollars.
The dynamic that drives this is the so-called unicorn culture, in which investors throw hundreds of millions of dollars at 20 companies in hopes that one will succeed. The large investments are fuelled by the growth of very large venture funds, where venture capitalists need to find companies that can absorb large amounts of funding.
There’s a better way to develop companies and generate returns, and it all starts with a more realistic approach to valuation.
There has long been a gap between Silicon Valley optimism and public market realism, and the drop off in IPOs appears to confirm Wall Street’s more sober view. But this isn’t necessarily a threat to one of the most vital segments of the economy, even if it portends an extinction event for unicorns.
Instead, it should inspire us to return to a more rational investment strategy — one that doesn’t rely on the unicorn fantasy.
There’s still plenty of reason for optimism in the tech sector, with game-changing technology advances rolling out to transform how companies do business in the data-driven economy and change the way consumers work, play, and connect. Smaller, faster, more nimble companies that don’t require massive resources to survive can rise in the unicorns’ stead.
Some observers have dubbed these survivors “cockroaches” in honor of their ability to persist through adversity that kills off larger competitors (such as unicorns). It’s not glamorous, but it is apt.
Perhaps what’s needed to maintain growth, rationalize investment, and generate reasonable returns is a conscious return to a more sober approach to valuation. That starts with realistic business plans and investor pitches that are based on real-world estimates rather than pie-in-the-sky projections. It works best when startups find investors who are truly aligned with their goals and ready to buy in to their business plans as they exist in the real world.
When companies can demonstrate real value and provide metrics that indicate true marketplace traction, they can work with investors to get the funds they need to scale up at a reasonable pace. This approach eliminates the perils of too-rapid growth, which often results in the waste of millions in funds on ill-advised marketplace moves and the loss of talent that can happen when pressures grow unbearable in the name of generating a fast buck.
If unicorns go extinct in Silicon Valley due to a market correction that closes the gap between private and public valuations, that might be a very good thing in the long run.
After the past decade’s excesses, a tech sector approach that involves demonstrating marketplace value and investors and company leaders aligning expectations and activities around reasonable objectives sounds almost quaint. But throwback notions like stability and realism might save the day yet, allowing smaller, more nimble and hardy survivors to emerge from the shadows.