The question is whether the privatization of a once-public market means that those getting left out are those doing the value creation - the coding, marketing, organization building etc - and what that means for the future of innovation. JL
Richard Waters and Stephen Foley report in the Financial Times:
Private capital-raising has provided fresh evidence of the tech industry’s financing boom has been limited to a charmed circle of investors. The risks of this cycle are being shouldered by a narrower circle of investors — but so are the rewards.With companies staying private longer, the “liquidity events” that cap successful start-up investing have been delayed indefinitely.
When he last turned to investors to raise cash a year ago, tech entrepreneur Ken Lin thought a stock market listing was looming on his company’s horizon. A rite of passage for many capital-hungry businesses, it seemed only a short period of time before he would follow the well-trodden path to Wall Street.
Last week, however, Mr Lin was back instead for another $175m round of private money for Credit Karma, the personal finance website that he co-founded. “There is a lot more you can do as a private company,” says Mr Lin, echoing the views of a generation of tech entrepreneurs who have learnt to shun the public stock market for as long as they can.By staying private, there is no need to waste time on sweating over quarterly earnings reports. “In public markets, you can lose the long-term view to focus on the short term,” says Mr Lin. And with investors lining up to pour cash into companies like Credit Karma, which has sucked in nearly $370m so far, the pressure to conform to Wall Street is off. “You can still raise the dollars in relatively short order, and still have the benefits of being a private company.”
Silicon Valley is in the midst of another investment boom, and it is unlike any that has gone before. The tech bubble at the end of the 1990s spilled out on to Wall Street as new companies with no record queued up to do initial public offerings. This time, with valuations once again soaring, the party is raging behind closed doors.The risk that another bubble is being inflated is only one of the anxieties. The surge of private investment has also raised questions about how well equity markets function on such a large scale without the high levels of disclosure and other checks and balances seen in the public markets.
The exclusive nature of the tech industry’s private investment frenzy has also stirred concerns about how widely the profits from the boom are being shared — and whether the investment game is only for privileged insiders with the right connections or the strongest investment clout.As a demonstration of the new supremacy of the private markets, last week was noteworthy. It began with news that Uber was on track to increase its total capital raising to $10bn, a record for a private tech company. That was followed by the revelation that Palantir, a secretive artificial intelligence company, was in talks to raise hundreds of millions of dollars at a valuation of $20bn, potentially putting it second only to Uber (value: $50bn) in the pecking order of private tech groups.Palantir’s new status was shortlived. By the end of the week, Airbnb was on the brink of a new investment round of its own, valuing it at $24bn, more than double the $10bn it was deemed to be worth 15 months ago. At $1.5bn, Airbnb’s fundraising involves more money than was raised in all but the five largest tech IPOs in history.The surge in private capital has left a dearth of IPOs. Last year, 59 tech companies went public, compared with 258 in 1999, though one was Alibaba, the Chinese ecommerce group that raised a record $25bn in its IPO.One result has been the proliferation of so-called “unicorns”, private companies that claim a valuation above $1bn, which number more than 144 globally, with 69 in the US.
The renewed burst of private capital-raising has provided fresh evidence of how the tech industry’s financing boom has been limited to a charmed circle of investors able to get a foot in the door of the hottest new prospects. All the risks of this tech cycle are being shouldered by a far narrower circle of investors — but so are the rewards.
‘Self-fulfilling prophecy’
Fast-growing tech start-ups once had little choice but to beat a path to Wall Street. “If you needed to raise $100m 10 years ago, there really was only one way to get it,” says Andrew Boyd, head of capital markets at mutual fund group Fidelity, one of the most active private market investors. “Now if you need to raise [funds], there is a sizeable group of investors making late-stage investments and it is not super clear that you should go public. Choice is good, and that choice is here to stay.”
And with the global economy still struggling, investors have found themselves with few alternatives when they are looking for high-growth businesses. “Growth has never been more valuable to investors than it is today,” says Jim Davidson, co-founder of tech private equity firm Silver Lake. Mutual funds, which are judged High quality global journalism requires investment. Please share this article with others using the link below, do not cut & paste the article. See our Ts&Cs and Copyright Policy for more detail. Email ftsales.support@ft.com to buy additional rights. http://www.ft.com/cms/s/0/bf1a4890-1be1-11e5-8201-cbdb03d71480.html#ixzz3eYFt5wSd
on their performance relative to their peers, are hungry for any edge they can get.
Hedge funds, private equity firms and sovereign wealth funds have also joined the rush, hoping to secure a piece of promising start-ups at just the moment their businesses really take off.
“It’s a little bit of a self-fulfilling prophecy: the only way to be part of the meteoric growth part of the curve is to be in the private market,” says Dylan Smith, co-founder of Box, an online storage company that rode the private market for 10 years before going public this year.
Wall Street short-termism has long been a complaint of tech companies, echoing Mr Lin’s barb about quarterly reports. Now they can point to a new embodiment of their fears: the activist investors such as Carl Icahn and Paul Singer’s Elliott Management who have taken to prowling Silicon Valley, putting pressure on underperforming public tech companies to cut costs, split up their businesses or sell themselves.
The long product cycles of many tech companies require patient investment and make them vulnerable to opportunistic attacks like this, says Scott Kupor, managing partner of Silicon Valley venture capital firm Andreessen Horowitz. That makes staying private for longer a form of self-preservation.
This has shaken up the normal order of the equity markets. Investors who once expected a considerable discount to invest in the illiquid shares of private companies now seem prepared to risk paying a premium, as shown by the IPOs of companies like Box, big data company Hortonworks and software company New Relic, each of which went public recently at a valuation below its last private round.
With investors still clamouring for a piece of the most disruptive new tech start-ups, this inversion of the normal state of affairs could well persist. The belief in the tech world is that the boom has longer to run, even if valuations look extravagant. Yet how this boom in opaque financial markets will unfold is now the subject of intense debate.To some, it has already accentuated a rise in prices. “When ginormous institutions do a little dabbling in a small asset class, they have a large price impact,” says Max Wolff, chief economist at Manhattan Venture Partners, which acts as a broker for investors looking to buy private company shares.
Adding to this upward pressure on prices, says one investor, is the lack of any ability to “short” the stocks of private companies. That removes one of the public market’s main mechanisms for tempering the excessive enthusiasm that sometimes breaks out in equities.
High rollers’ table
There is also heated debate about the essential fairness of the new market structures that are emerging. Companies that are able to pick and choose between potential backers are often selecting groups like Fidelity, T Rowe Price and Wellington, leaving smaller institutions and private investors out in the cold. This has led to a “bifurcated market”, says Mr Kupor at Andreessen Horowitz, one of the VCs that has invested most aggressively in the boom. “We’re certainly closing off a large part of the market to the broader retail [investor] base.” Private investors like Andreessen, he adds, will benefit “disproportionately”.
If the previous tech boom sucked naive personal investors High quality global journalism requires investment. Please share this article with others using the link below, do not cut & paste the article. See our Ts&Cs and Copyright Policy for more detail. Email ftsales.support@ft.com to buy additional rights. http://www.ft.com/cms/s/0/bf1a4890-1be1-11e5-8201-cbdb03d71480.html#ixzz3eYGBAHMF
into a bubble, the opposite is now the case. Under US regulations, only “accredited investors” — those with substantial personal assets — are allowed into private investments.
But even most of these have no way of investing, unless they are clients of a powerful investment bank or want to take their chances buying on one of the private secondary marketplaces that have started to spring up.
Those forced to wait until hot companies like Uber go public are likely to miss out on the biggest gains. “By the time a deal gets to the public, it will be a shallower growth curve,” says Lise Buyer, an adviser on IPOs who worked on Google’s public listing a decade ago.
There is also a danger that new incentives engendered by the private market will create unanticipated risks. The greatest risk, according to experts, may stem from the terms that private investors often demand to protect themselves in the event that a company goes public at a lower valuation. Under an arrangement called a “ratchet”, these investors receive extra shares to compensate for any shortfall, diluting the interests of other shareholders.
Companies that grant ratchets are not really valued as highly as they claim, says Jay Ritter, a finance professor at the University of Florida. In effect, they have given investors a free insurance policy — a sweetener that is not reflected in the headline numbers.
Claiming a valuation of $1bn, a level that brings the much-desired status of “unicorn”, has become a way to attract attention in the absence of a full public listing. That many companies claim to have just reached or narrowly topped this level suggests that they have granted special backroom terms like ratchets to get an extra lift, according to law firm Fenwick & West.
Those who suffer from this are likely to be tech company employees who are paid partly in stock that does not have any downside protection, says Ms Buyer. Investors who buy in secondary markets and are misled by the headline valuations into overpaying could also be hurt.
Cashing in the chips
The last and most important chapter in the tech boom is yet to be written. Even as venture capitalists and other private investors watch the notional value of their holdings soar, they cannot escape the fact that none of it means anything until they cash in their chips. With companies staying private longer, the “liquidity events” that cap successful start-up investing have been delayed indefinitely.
“At some stage every investor will want to take liquidity, whatever their horizon is,” says Mr Smith at Box. Certainly, the mutual funds that have crowded into the private markets have made it clear they are there with an expectation of IPOs in the near future.
“Our opportunities are in those that will typically IPO,” says Mr Boyd. “We do not look at assets that will get flipped to a strategic buyer.”
The day of reckoning for hot private tech companies has been pushed back. But all investment cycles turn. The older this one gets, the greater the risks.
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Jobs Act: Law to cut red tape offers incentive to stay private
One of the main forces behind the upending of the usual order in US equity markets has been a piece of legislation that backers claimed would encourage companies to go public, but has had the opposite effect.
The Jumpstart Our Businesses Act was intended to cut the regulation on companies looking to go public. Signing it into law three years ago, President Barack Obama said it was important for more growing companies to list their shares on Wall Street. Public companies tend to expand and hire more workers, he said, and they “operate with greater oversight and greater transparency”.
Buried in the legislation, however, was a provision that turned out to be a gift for companies preferring to escape the rigours of being publicly listed.Previously, private companies had to publish detailed financial information about their operations when their shareholder numbers hit 500, a requirement that was often a catalyst for an initial public offering, since it removed one of the main attractions of staying private.
Facebook’s IPO in 2012, triggered after it hit the 500 shareholder limit, drew attention to the rule. By lifting the limit to 2,000, the new law has removed the pressure to list.
Critics argue that this has barred ordinary stock market investors from investing in the hottest new tech companies. “The outcome of the Jobs Act was to widen the gap between the haves and the have-nots,” says Lise Buyer, an IPO adviser in Silicon Valley.
Other pieces of financial regulation have had a bigger effect on discouraging companies from seeking a listing, market participants say. Much of the criticism has been levelled at the Sarbanes-Oxley Act, which was passed in the wake of the Enron scandal and has been widely attacked in Silicon Valley for imposing excessive regulation on young companies.
“The infrastructure on which our public markets are built is all from the 1930s, and the patches on top of that operating system have led to a situation where companies do not want to be public,” says Rett Wallace, founder of Triton Research, a private company research firm.
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