Selling Dollars For 85 Cents

Writing on Above the Crowd, Bill Gurley digs into the recent spate of ultra-high valuation startup investments. 

Over the last few years, the late-stage (pre-IPO) market has become the most competitive, the most crowded, and the frothiest of these financing stages. Investors from all walks of life have decided that “late stage private” is where they want to play. As a result, a “late-stage” financing is no longer reserved for high-revenue, pre-profitability companies getting ready for an IPO; it is simply any large round of financing done at a high price. An unprecedented 80 private companies have raised financings at valuations over $1B in the last few years. These large, high-priced private financings are the defining characteristic of this particular technology cycle.

Conventional wisdom in the post Web 1.0 era has been that a "normal" state of affairs would be for these relatively mature companies to have reached an IPO already by this point, but due to a variety of terrors — lawyers, regulation, Sarbanes-Oxley, and so on – these poor companies have no choice but to resort to private equity. Gurley points out that this conventional wisdom is both incorrect and dangerous. 

Actually, very few of these companies are at a point where they could or should consider being public. Lost in this conversation are the dramatic differences between a high priced private round and an IPO.

The first critical difference is that these late-stage private companies have not endured the immense scrutiny that is a part of every IPO process. IPOs are remarkably intense, and represent the most thorough inspection that a company will endure in its lifetime. This is why companies and their board of directors agonize over whether or not they are “ready” to go public. Auditors, bankers, three different sets of lawyers, and let us not forget the S.E.C., spend months and months making sure that every single number is correct, important risks are identified, the accounting is all buttoned up, and the proper controls are in place.

He goes on to highlight the many minefields present in these deals, things like shady tactics in reporting gross vs. net revenue, or the broader problem of investing in a business that has had its economics severely distorted by the infusion of enormous amounts of capital, and are "simply selling dollars for $0.85."

All of this suggests that we are not in a valuation bubble, as the mainstream media seems to think. We are in a risk bubble. Companies are taking on huge burn rates to justify spending the capital they are raising in these enormous financings, putting their long-term viability in jeopardy. Late-stage investors, desperately afraid of missing out on acquiring shareholding positions in possible “unicorn” companies, have essentially abandoned their traditional risk analysis. Traditional early-stage investors, institutional public investors, and anyone with extra millions are rushing in to the high-stakes, late-stage game.

Story: Late-stage Private Rounds Are Very Different from an IPO

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