For those concerned about a bubble in startup land, the number of VC-backed companies attracting valuations north of $1 billion increased sharply this year. “This clearly is shaping up to be the best year for IPOs in a decade,” said Steve Case, the former head of AOL and now head of his own private investment firm, Revolution. IPOs are at the core of U.S. and global economic growth and job creation. A sustainable IPO market requires valuations based on fundamental performance over the long-term. Today’s markets are focused instead on short-term trading profit extraction. A bubble or the beginning of a new, higher trend? You be the judge.
You may disagree on whether Dropbox is worth an estimated $9.6 billion, Pinterest, $3.8 billion, or Uber, $3.5 billion. But you will agree on this: All are rich valuations and a surge of pre-IPO money is fueling them to extraordinary heights.
“This is momentum investing,” said Tim Guleri, managing director at Sierra Ventures. “Overall, too much of this is a dangerous trend.”
The danger will mount with any change in the IPO window, or if public valuations fail to recover from their March selloff. Either could place private company valuations under pressure and chip away at the market value of portfolios priced off them. (Note: DropBox announced last week they were postponing their IPO until Summer and EverNote has said they are postponing their IPO stating "they're not ready", as has payments company Square and Credit Karma)
Anytime there is a bull market, outside money wants to get into late stage financings, said Jules Maltz, general partner at Institutional Venture Partners. “That works as long as the market continues. As soon as the market changes, we often see these funds pull back.”
Whether these funds will retreat is hard to gauge. So far, there are mixed signals. Tiger’s ability to close on a new $1.5 billion venture fund in April suggests access to capital is not likely a restraint. However, Coatue in March said it planned to return $2 billion to investors, suggesting second thoughts are creeping in.
Equally significant is the massive size of the transactions. Hedge and mutual funds have participated in 14, or 60 percent, of this year’s largest two-dozen U.S.-based deals with disclosed investors (and it's only May 2nd), compared to about 38 percent last year.
“You are seeing some willingness to write large checks for select companies with a winner take all paradigm,” said Timothy Keating, CEO of Keating Capital. “I do believe you are seeing some inflation in those highly publicized companies.”