It’s not unusual for an IPO to backfire, resulting in stock prices that drop but ultimately recover over time.
However, among tech startups, this situation is becoming more of an expectation than an occasional problem, making both IPO and pre-IPO investors extremely nervous. Some speculate that the problem may lie in overvaluation of private companies before they go public.
The Trend of Startup Overvaluation
There’s a lot of hope that the next clever tech startup will be the billion-dollar winner, now more than ever.
Currently, North American venture firms have an estimated record $96 billion in uninvested capital, just waiting for the right opportunity. In addition, SoftBank Group Corp has recently launched a $100 billion vehicle to invest in young tech firms, creating the largest fund for such purposes ever.
Private tech firms are taking advantage of so much eagerness to invest, and valuations are going crazy. Right now, there are about 170 companies valuated by their owners at $1 billion or more, 13 of those are now valued at over $10 billion. These numbers don’t sound all that outrageous unless you consider that just a decade ago, before the financial crisis that rocked the United States, no venture-backed company had ever reached $1 billion in valuation before its IPO, according to reporting by the Wall Street Journal.
IPOs are generally priced to outperform benchmarks, but currently, the startups behind them are struggling to keep their heads above water. U.S. IPOs are seeing an 11 percent increase right now, on average, but that’s barely better than the S&P 500’s 10 percent growth. Tech IPOs are only up 19 percent, against the S&P 500 tech sector’s gain of 22 percent.
Startups May See a Correction
Companies like Snap, Blue Apron, Uber and even Pinterest are still trying to raise funds for long-term growth and profit, but are largely losing money. Businesses following them may find that investors begin to turn an icy shoulder, especially considering how much highly publicized loss Blue Apron has experienced.
“Private companies sometimes have unrealistic expectations that prices will go up consistently,” Roelof Botha, a partner at Sequoia Capital, told the Wall Street Journal.
That’s an understatement for valuation problems at Blue Apron. Although initially valued at about $2 billion in a 2015 private investing round, its banking team attempted to value it at $3 billion in the lead-up to its IPO. What actually happened was a sharp drop in stock prices that can’t seem to stop. Currently, Blue Apron is worth less than $1.3 billion, and if it can’t figure out how to increase its margins, investors will continue to bail.
Snap’s story is much the same. After an initial IPO at $17 per share, it’s now sitting at $13.67 and is trading at below the company’s last private funding round. How all of this will affect startup IPOs in the long run is hard to say, but for the moment, they look to be in big trouble as poor planning for growth creates massive losses for backers.