Dear readers,
Another intense month is about to finish, and as we continue to chart our way through 2024 it feels that we are entering a period of “normality”. I had the honor to speak last week at the Greenwich Economic Forum Miami on the topic of Valuation Reset in the Venture Capital and Private Equity segments, and shared my views on how that was playing off in the world of (high-growth) disruptive technology companies.
Not only are valuations resetting – though the final line is yet to be reached – but the macroeconomic environment seems to be settling. Though inflation is stickier than anticipated, the Fed is still on track to deliver as much as three rate cuts this year. Both combined offer hope for an IPO window reopening, easing pressure in the VC world. I want to shift the focus of this month’s introduction on IPOs.
The pandemic and macroeconomic context created a perfect environment for high-growth disruptive technology companies to develop in the private markets. Free money allowed to fuel growth with little control on the money spent birthing a generation of zero interest-rate babies (ZIRBs). As of February, the 600+ US unicorns with billion-dollar-plus valuations represented the equivalent of c.7% of the U.S gross domestic product.
Then came 2022 and unprecedented rate hikes which put brakes on growth and put path to profitability central stage. Many investors new to the asset class retrieved from Venture Capital which suddenly appeared risky, and valuations were questioned as public stocks of unprofitable tech companies eroded. As a result, exits have stalled for almost two years, and ZIRBs face intense pressure to fix their sometimes broken business model, for those that are still alive.
Things may now finally be changing allowing for cautious optimism.
But the IPO window reopening expected in the next months raises unprecedented challenges due to the amount of private companies seeking to enter the public markets. First, not all companies will be able to list. For those who manage to, delivering correct returns to investors will be critical to avoid the painful vintages of 2020/2021.
So how can entrepreneurs and investors anticipate the IPO window reopening and navigate the long-awaited IPO route?
This first starts by understanding what is the right valuation metric that will apply to the company. Though this is relatively straightforward for many companies in SaaS for example – where valuation is based on Annual Recurring Revenue (ARR) – things get tricky in businesses for which the valuation aggregate is not obvious. For example, Fintech companies will not necessarily be valued per recurring revenue multiples if investors judge that the company is not a technological asset but a tech-enabled "material world" company (i.e., a bank) with resulting aggregates. This is what happened to WeWork no matter how much times the word “tech” was sprinkled in the S1. What will make the difference here is to what extent entrepreneurs can prove the degree of both the recurring and technological aspect of their revenue.
The next question is that of the multiple itself applied to that suitable aggregate. Valuation of high-growth disruptive technology companies show a direct correlation to growth. Growth wins over profitability as a result of its compounding effect. Thus growth, and more high-growth (the degree to which will depend on the stage), justifies a premium. For this, investors will have to believe that growth is durable and the result of a solid economic engine, rather than the result of favorable macroeconomic conditions or mere sector tailwinds. For entrepreneurs, this is a fantastic opportunity to take the time to do an introspection exercise and to understand one’s specific “growth equation”: what are my two or three critical growth levers that when actioned produce outsized results? This will allow to prioritize spend on those levers only in a world of expensive capital – but also to set-up the right tracking to ensure that they are on track with their growth plan.
Efficient growth that will result from understanding this equation, i.e. one which requires the minimum level of spend per new dollar of ARR, can and should be evidenced to those pre-IPO investors who will invest in the coming months in pre-IPO rounds and guarantee through their presence a part of the IPO success.
Confidence in high-growth disruptive technology companies has been strongly eroded in the past months. But the good news is that liquidity is abundant for best-in-class startups. For late-stage entrepreneurs, now is the right time to build a compelling exit story evidencing the critical growth levers. This will unlock high returns at investor level at IPO while allowing for long-term value creation at company level.
Thank you for reading! And Happy Birthday to the whole team at D’Ornano + Co. as we enter our 9th year!