David S. Bennahum, Venture Partner @alphavp
This is the second part of a series. The first, on pricing unicorns, is here.
This isn’t the first era of great technological innovation: The early 1980s saw the explosive growth of personal computers and video-game consoles; the 1990s saw the onset of the desktop Internet– yet in neither of these times did fast-growing, private technology companies chose to stay private for very long. Most successful technology enterprises held an Initial Public Offering (IPO) within their first five years of existence.
Today the mean time to IPO for technology companies is no longer 4 years as it was in 1999, but 11 years. The drying up of the marketplace for technology IPOs– in particular for tech companies with revenues under $1 billion– is the underlying factor that’s driven the rise of so-called unicorns (see part one for a review of unicorn pricing).
How low can the tech IPO market go? Here’s a chart showing that tech IPOs by volume are back to where they were in the mid-1980s:
Benedict Evans at Andreessen Horowitz published research in June examining the scope of the trend. The Economist made a similar argument in late July. In August, PitchBook, an essential database of private financings, produced their own research titled The Emergence of the “Private IPO”.
What makes this trend interesting is that the size of the technology market has grown immensely in the past twenty years, which would imply more IPOs not less. Take the mid-1990s as a point in time (when the commercialization of the Internet began). In 1995, 40 million people were online. In 2015 it’s four billion. A 100x increase. Then look at eCommerce and online ad-revenue in the United States, which grew 15-fold in approximately the same period, from about $35 billion in 1999 to $400 billion today.
How could public offerings for technology companies decline while the total amount of economic activity in the tech sector grew exponentially? The answer lies in a number of trends have little to do with the tech industry:
- The cost of being a public company: Complying with various regulations; the threat of public shareholder activism driven by short term gains vs long term strategy; and regulatory burdens (ie. SARBOX) meant for multi-billion dollar companies, not smaller high growth companies. When Michael Dell took Dell private in 2013, he explained in a Wall Street Journal editorial: “We find ourselves in a world increasingly afflicted with myopia…. This was what Dell faced as a public company. Shareholders increasingly demanded short-term results to drive returns; innovation and investment too often suffered as a result. Shareholder and customer interests decoupled.”
- The availability of private capital: Persistently low interest rates have driven down yields, driving institutional investors such as hedge funds, sovereign-wealth funds and large firms to participate in late stage financings that, historically, would have been conducted in a public market.
- The decimation of investment banking sales and research for small cap stocks: In 2001, stocks began to be traded using decimals, instead of fractions (?, ¼, ½, etc.), the idea was to make stock prices more transparent, but the laws of unintended consequences have since meant that decimalization contributed to the decimation of small-cap IPOs. The old-fashioned fractional trading system produced slightly higher margins for the market-makers of public offerings (as stocks were more expensive to trade with fractions). These margins paid for the research coverage and analysis of lucrative aftermarket small-cap public offerings (such as under $50M). That’s gone (here’s a deep dive on the fascinating relationship between decimalization and the drying up of small-cap IPOs).
The net effect has been the arrival of the unicorns and a very unusual ecosystem: fast growing private companies generating significant revenues, with no obligation to go public, let alone disclose performance to the public.
In the next piece, we’ll look at how the rise of unicorns signals a shift in investor returns, from public to private markets, with profound implications for future innovation and investor strategy.
About @dbennahum
Venture Partner / @alphavp. Co-Founder CEO / @Kandu. Co-Founder CEO / Punch. Founder / The American Independent News Network. Director & Advisor / DailyCandy, MediaBistro. Founding Writer / Wired. Analyst / McKinsey & Co. BA / Harvard College. First computer: Atari 800. First programming language: BASIC. LinkedIn