San Francisco Chronicle - (Sunday)
For new investors, IPO not as appealing
The latest generation of Bay Area startups is sprinting to the public markets, raising hopes among large and small investors eager to invest in these high-profile, fast-growing firms.
But the class of 2019 is far different from its predecessors. These companies, including gig economy darlings Uber and Lyft, are generally older and larger, powered for years by billions of dollars of private money that has reshaped the startup world.
The additional maturity of the companies may curb wild swings — both big gains and
big losses — for new investors.
But it could also mean that the companies’ fastest phases of growth are behind them. As a result, there is an increased risk that in this wave of tech IPOs, an elite group of investors, like sovereign wealth funds and venture capitalists, will grab a larger share of the winnings compared with new investors.
“Individual investors are going to get in too late,” said Jason DeSena Trennert, managing partner at Strategas Research Partners, a markets and economic analysis firm. “They’re going to be the last investors in, and that’s the concern.”
The change reflects a large-scale shift in the way American entrepreneurs raise money to build their companies. Instead of quickly turning to the public markets and the scrutiny that comes with that, as Amazon and Google did, they are building huge businesses over the course of many years on the back of private money, and with fewer demands for financial disclosures.
Uber, the giant San Francisco ride-hailing company, has raised more than $20 billion over the past decade. Lyft, its smaller rival, raised $4.9 billion over seven years before it started trading publicly Friday.
Many startups in earlier waves — back to the dot-com boom of the late 1990s, when Amazon was listed on the Nasdaq — went public just a few years after their founding. Some, like Pets.com, had tiny amounts of revenue and now exist only in Silicon Valley lore.
A combination of policy changes and vast new riches in the tech industry has been changing the equation for startups for more than a decade. Mutual funds and hedge funds — the typical investors in a startup’s IPO — began buying stakes in large private companies as a way to build up larger stakes before the new businesses went public. Other big investors joined in, including large sovereign wealth funds and the outsize SoftBank Vision Fund, creating an even hotter market.
Venture capital investments into U.S.based companies grew to $99.5 billion in 2018, the highest level since 2000, according to CB Insights, a company that tracks startups.
Those investments have driven valuations of startups to unusual heights. There are now at least 333 unicorns, companies valued at $1 billion or more, according to CB Insights. In 2014 there were around 80.
Before it went public, Lyft had a private valuation of more than $11 billion. Investors have valued Pinterest, another San Francisco company going public, at a similar amount. That is roughly the market value that public investors put on retailer Kohl’s and online trading firm E-Trade Financial.
Uber, the largest of the private companies expected to head for the stock market this year, has a private-market valuation of more than $70 billion. In public markets, that’s roughly the same size as corporate giants such as Goldman Sachs and CVS Health.
Matt Murphy, a partner at Menlo Ventures, a leading venture capital firm, said the higher valuations and larger investments correlate with bigger opportunities created by smartphones and cloud computing.
“The magnitude of the audiences that can be reached and the monetization per user has grown,” he said. “Their growth potential is much higher than was previously anticipated.”
Some industry groups and investors who urge fewer regulations say the emphasis on the private markets is an outgrowth of the Sarbanes-Oxley Act, the federal law passed in 2002 that tightened accounting rules for public companies after the accounting scandals of the early 2000s.
Besides raising disclosure requirements and other changes, the law required top executives to attest to the accuracy of corporate financial statements. Some say those higher costs to guarantee compliance can dissuade smaller companies from going public.
Private companies, by comparison, can operate with far less disclosure. They are under no obligation to file quarterly earnings updates or audited annual financial statements with the Securities & Exchange Commission. Nor are they required to broadly distribute updates on business developments to the public.
Others say the decline in public offerings began before SarbanesOxley passed. They attribute the change to a wave of federal deregulation, which made it easier to raise money and sell companies privately. Lighter antitrust enforcement set off a boom in mergers and acquisitions, allowing smaller firms to sell to bigger companies instead of going public.
At the same time, new laws made it easier for private companies to sell securities to qualified investors around the country, boosting funding from private equity and venture capital.
Whatever the driver, the net result has been a clear downturn in the number of public companies in the United States. The number of listed companies has declined by 52 percent since 1997, to a bit more than 3,600 in 2016, according to a working paper from the National Bureau of Economic Research published last year.
This long-term shrinkage in publicly available shares is a reason that some analysts expect Uber, Lyft and other prominent startups to receive a warm response from the institutional investors who typically buy freshly issued shares, even if the potential upside could be smaller.
“There’s an element, I think, of pent-up demand here,” said David Ethridge, who advises on public offerings at consulting firm PwC. “I think people will have a feeling of, I don’t really want to miss out.”
Investors have some reason to be skeptical of paying top dollar for newly minted public companies, though. Over the last two years, the value of companies that completed public offerings actually fell by an average of 8 percent, according to a recent research report from Goldman Sachs analysts.
Over the same period, the S&P 500 was up about 12 percent.