Unicorn pre-IPO valuations: should we be worried?

Uber: 40bn$, Spotify: 6bn$, Dropbox: 10bn$. Do these valuations actually correctly reflect just mind-boggling business fundamentals or is there another less obvious common denominator? Well, while each of these equity stories is certainly unique, having Goldman Sachs as their principal cash-fuel provider turns out to be an essential element these players do actually have in common. A bunch of massively funded companies are currently seeking to make it to the public markets and are (quite rightly so) trying to advertise an unbroken and steep valuation uptake before going public. However, experienced investors are getting increasingly uneasy about the emergence of private convertible bond investors and hedge funds on board of these pre-IPO bandwagons.

“To me this looks like the precursor for significant post-IPO underperformance if companies with jazzed-up pre-IPO valuations finally hit the public markets” says Ventech Partner Christian Claussen. “Access to huge convertible debt facilities for notoriously unprofitable companies is just another facet of a general pattern”. Christian who has learnt his early lessons as a VC in the ’97-’00 tech bubble feels oddly reminded to stock-price boosting-techniques such as the famous ‘laddering’ which in hindsight were part of Wall Street’s bubble-tool-box heralding a 7 year nuclear winter for the European VC-industry (read the chapter on bubble #2 in this witty backgrounder).

For Ventech Partner Jean Bourcereau things are not even half as bad. “History does not repeat itself and I do not predict a 2000-like situation where excessive pricing was only one factor besides fundamentally unsustainable business models and systematically boosted market size estimations”. As a worst case scenario Jean rather foresees a potential 2008-like situation: “Who knows, we might eventually be in for a global 30% haircut on tech stock prices. And while this definitely hurts it doesn’t kill anybody as long as portfolio companies are well prepared and geared”.

Whether or not it’s already time for another issue of “Sequoia’s Doomsday Portfolio Briefing”, we strongly believe it to be good practice for European privately held companies to constantly prepare for a potential overall decline in investors’ confidence. Measures to protect your company against the odds of access to fresh equity include

· The build-up of equity reserves and permanent control of cash burn in order to have maximum runway

· A general focus on profitable and lean business models embracing early monetization strategies; we generally believe it to be rather risky for European start-ups to bet on strategic “zero-revenue acquisitions”; even an unproven “path to profitability” is in most European exit scenarios obstructing successful trade sales or IPOs

· Turning management’s attention to every company’s real assets: team quality, an on-going optimization process for the underlying business model, happy long-term customers, competitive entry barriers, margin control etc….