While nearly 150 private tech companies have achieved a valuation of more than one billion, their public counterparts have performed poorly. The landscape for investors has changed with firms staying private longer.
According to CB Insights, 146 privately held technology companies have achieved unicorn status, i.e. are valued at more than one billion USD. Moreover, 13 private companies are “decacorns” and valued above $10 billion. On the other hand, many technology companies that went public have performed poorly. More than 40 percent of the unicorns that went public since 2011 could not increase their final private-market valuation or have even devalued, says a study of Battery Ventures. Research from McKinsey identifies a new landscape that calls for different investment models for early- and late-stage investors as well as different funding approaches for companies.
The average age of US technology companies that went public public in 1999 was four years, says an analysis form the University of California. In 2014, software companies went public at an average age of eleven years. Moreover, more companies reach their one billion valuation while they are privately held. Only six of the 35 companies that reached unicorn status between 2004 and 2015 did so while being privately held. The first private software company reached its unicorn status in just 2010. Five years later, 146 software unicorns are privately held.
Reasons for this development are regulatory changes that allow a larger number of shareholder before a company must disclose financial statement, and sharply increasing venture capital investments. In the past two years, investments into private companies tripled from about $26 billion in 2013 to $75 billion during 2015. Finally, markets seem to prefer large firms, according to McKinsey, larger companies are valued at higher multiples and perform better.
Companies staying private longer affects investors. They must wait three times as long to realise returns than they did a decade ago. Especially later round VCs can no longer count on an IPO to cash out. But early investors are affected too. Waiting eleven years to realise returns is tough in a business that normally raises new capital for funds ever two to four years. To tackle this issue, realising returns through M&A transactions is increasingly an option.
Moreover, an increasing number of down rounds, financing rounds that decrease the value of a venture, are an issue - not as much for investors but more for employees and entrepreneurs. While the valuation doesn't really matter for an investor until they exit, companies face a reputational loss and employees that are paid with options suffer, if the value falls below the strike price of their stock options.
A private company enjoys some benefits, says McKinsey. It allows to focus on the long-term strategy, retain the competitive advantage that comes from not disclosing business details, minimises resources spend on shareholder-facing activities and protects the company from activist investors and takeovers.
However, an IPO is often inevitable: First, companies with more than 2,000 investors are legally required to disclose financial information, which might trigger an IPO. Second, investors seek liquidity and want to realise their return, normally within seven to ten years, forcing firms to go public. Besides, going public at the right time allows to financing further growth, increases credibility and attracts talents. “Regardless of the market outlook, getting the timing right for the transition from private to public helps set up software companies for long-term success,” says McKinsey.