TECH VALUATIONS ARE IN THE SPOTLIGHT.
Early and growth-stage tech valuations have increased to levels not seen since the dotcom bubble. We are hoping the Pure Storage IPO could serve the valuable purpose of getting investors to cool their jets at least a bit. The accelerating pace of minting new unicorns (a silly term we don’t love around here) is probably due for a breather. The Wall Street Journal reports there are currently 123 private companies with $1 billion + valuations. There were only 43 of them in January of 2014. Pushing for the billion threshold just for the sake of claiming that title is like rushing into marriage without knowing what you’re getting into. It absolutely could be great, but it could also end very badly.
There are growing concerns that this is the new “new thing”. Let’s be honest, people have been overheating markets since markets have existed. It’s possible that Cain killed Abel out of frustration with Abel’s wiser trading in the mutton markets relative to Cain’s poor trades in commodities. There was the Gold Rush then the Silver Rush both promoting trading in shares in non-existent mines. From Milken to Pets.com and from overinflated leveraged lending to the housing bubble we have seen a lot of people rushing too hard and fast toward the latest thing.
SHOULD WE BE WORRIED AS WE WATCH VENTURE (PRIMARILY TECH) VALUATIONS CONTINUE TO RISE?
We don’t believe there is reason for too much concern yet. Hopefully the Pure Storage IPO will serve as a reminder to investors that the public markets are not exactly the desirable exit they once were. That could lead to a healthy dose of caution.
Strategic sales will continue to be the preferred exit mechanism. There may be 123 private companies with $1 billion + valuations, but current large public companies have hundreds of billions sitting on their Balance Sheets and SaaS and other tech targets with fast recurring revenue growth and high margin potential could be highly accretive acquisition targets.
To be clear, as heavy users of tech innovation, we definitely see the tremendous value and efficiency gains being created by these companies. Many absolutely merit their high values as they take down the slow moving giants of yesteryear. It is one of the ugly, yet healthy aspects of our economy. Survival of the fittest is not pretty, but it yields a healthy herd. Uber and Lyft may kill taxi companies, but the adapt-or-perish nature of the economy is overall a good thing.
QUESTIONS?
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For the companies that don’t merit their high valuations, some subpar returns on individual investments are baked into the VC return model and VCs are partially insulated from too much downside given the preferences in their investments. So even if valuations are on the high side, we don’t see tremendous collateral damage potential. However, we absolutely do believe it would be a healthy thing for investors and companies alike to seek fair valuations that reflect reasonable assumptions around future cash flows and exit opportunities. We all have to know that focusing on fundamentals can never be a bad thing…right?
AUTHORED BY TRENT READ
Trent has been a CFO of two venture/growth equity-backed companies that ranked on Inc. Magazine’s list of fastest growing companies in the country which he successfully led from their infancy to full liquidity events. He began his career as an Analyst in investment banking with Deutsche Bank. He was then a Senior Financial Analyst for a $200 million business unit of Honeywell. He then returned to investment banking as an Associate and then VP at Wachovia Securities and Sagent Advisors respectively. He worked with media, digital media, telecom, software/SaaS, and internet infrastructure companies on transactions that varied from multi-billion dollar LBOs to small growth equity capital raises. Trent is now a partner at EP and is the head of EP’s Utah valuation practice.
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