Wednesday, January 07, 2015

Private market intoxication, Public market sobriety

From Sigalow:
The number of privately-held companies valued at over $1BN is at an all-time high.  There are currently 40 venture-backed start-ups valued at over $1BN in the private markets, and 27 of these companies are headquartered in San Francisco. Investors assume that each and every one of these Unicorns will have a successful IPO at many multiples of its current valuation.

In case you believe the public market will absorb these companies at a premium, here is a point of reference. There are only 71 publicly-traded technology companies headquartered in Northern California with a market cap of at least $2BN… and this list is declining at the same rate as the market in general. Meanwhile SF-based VCs have been minting similarly-valued companies, in the private markets, at a rate of one per month for the past two years.

Earlier this year one of my partners made the comment that we are witnessing “private market intoxication and public market sobriety.” I have been struggling to explain why this is happening, and I think the answer lies in a structural difference between VC investors and public market investors.
40 private market companies, valued at $1B+, all with expectations that they will trade at multiples of that ($3B+? $5B+?) when the number of such extant companies is only 71 in California?

(Note the weird math. Why are we limited the number of public companies at $2B valuations to California? Quick googling does not give me an answer -- please post in comments if you know. Let's assume the actual number is 200. So 40 companies out of 200 is 20%. An optimistic amount.)

This is the private market bubble I've mentioned earlier in my blog. The incentives in the VC industry mean they have to swing for the fences to justify their fees to LP, which means the asset class as a whole is likely to underperform. LPs will then either adjust their portfolio out of the asset class, or remain inside it betting they can  beat the odds as they continue to reach for yield in our current ZIRP environment.


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