Tech start-ups drop stay-private mantra as IPOs beckon

“It’s now less expensive to raise capital in the public markets than the private markets,” something that hasn’t happened in a long time, said Tomasz Tunguz, a partner at Redpoint Ventures.

Still, the median age of venture-backed tech companies holding IPOs this year is a mature 12 years, according to data compiled by Jay Ritter, a professor of finance at the University of Florida. And the late-stage venture market remains robust, with the number of deals valuing venture-backed companies at $1bn or more reaching a record in the second quarter, according to PitchBook Data.

At the same time, more earlier-stage companies have been finding their way to public markets.

Digital insurance start-up Lemonade, founded in 2015, was the youngest venture-backed tech company in more than two years to hold an IPO when it went public in July, according to Ritter’s data. Venture-backed Root, which started selling auto insurance just four years ago, followed suit with an IPO last week.

In recent years, the trend of companies staying private longer has reshaped the venture market, pushing venture firms to raise ever-larger funds and fuelling the secondary markets for private stock. Any reversal or weakening of that trend could affect venture-capital activity, especially in later stages.

Some entrepreneurs choosing to go public earlier are wary of the disappointing stock performance of older companies that went public last year, such as Uber Technologies.
“They did all the growth with VCs and then they heaved themselves on the public market that didn’t appreciate them,” said Daniel Schreiber, chief executive and co-founder of Lemonade, who declined to name the specific companies he had in mind. He added he also was concerned about company culture.

“When you get to be that big without being transparent, I don’t think it instils good culture.”

Most of the younger start-ups are listing this year via Spacs. Almost two dozen venture-backed tech companies have signed deals to be acquired by Spacs, according to WSJ Pro Venture Capital’s analysis of data from Dealogic and PitchBook as of 23 October. Their median age is about seven years old. Some have little or no revenue.

Many more tech start-ups are being approached by Spacs that haven’t found an acquisition target yet, VCs say. About 165 of the SPACs that went public in 2019 and 2020 and have raised about $53.6 billion are in that camp, according to Dealogic. “It’s coming up at lots of board meetings,”  Tunguz said.

“As SPACs started to become more prevalent, we saw an opportunity to make that leap [to the public markets] earlier than we would have otherwise,” said Arjun Aggarwal, vice president of product and business development at Desktop Metal Inc.

Founded in 2015, Desktop Metal makes 3-D printing equipment and expects to generate between $15 million and $25 million in revenue this year, down from $26m in 2019, according to its investor presentation. Its deal with blank-check company Trine Acquisition and related transactions would value Desktop Metal at up to $2.5bn and provide up to $575m in gross proceeds to the company.

Desktop Metal considered the trade-offs in going public, such as more onerous reporting requirements, according to Aggarwal. But the advantages of raising cash that the company can use to compete better outweighed any of the negatives.

“At some point you have to be a grown-up,” he said.

“For over 20 years in Silicon Valley, founders have been taught that staying private longer and going public later is a good idea,” said Arjun Sethi, co-founder and partner at venture firm Tribe Capital, whose early-stage portfolio company Momentus is being combined with a blank-check company. But going public earlier “is always healthier because it presents more transparency and accountability,” Sethi said.

The shift also is affecting public investors. As earlier-stage companies list, public investors can capture more of the growth that for too long has been accruing to late-stage private investors, Desktop Metals’  Aggarwal said.

But some worry that too many speculative ventures could disappoint investors by listing too early.

“It feels a little more Wild West,” said Matt Murphy, a partner at venture firm Menlo Ventures, speaking about Spacs in particular this year. “The real question is, do we come out of this with the majority of these companies doing well, then it should be sustained, or is this a bubble of people looking to make quick money.”

Spacs appeal to less mature companies because the process allows them to discuss future projections with a targeted set of investors, provides certainty around deal terms, and enables them to raise money faster with fewer disclosures than via traditional IPOs, supporters say.

Companies that are listing are rediscovering the attractive part of the public market: its vast size.

“There are trillions of dollars for infrastructure and agriculture [in the public markets], whereas there are no trillions of dollars available in venture capital,” said Jonathan Webb, founder and chief executive of Kentucky-based indoor farming start-up AppHarvest. The pre-revenue start-up founded in 2017 is raising $475m at a valuation of about $1bn via Spac-related transactions.

The public markets have been giving a warm reception to venture-backed tech companies going public via IPOs. As of mid-October, their IPOs had a median first-day stock-price pop of 81%, up from 35% for such IPOs in 2019, according to Ritter’s data.

Geopolitical uncertainty also has pushed more companies to consider going public, venture investors say.
“There’s a premium now to getting out to public markets earlier given upcoming uncertainty around the election and what next year looks like with [Covid-19], particularly with public markets being as strong and receptive and as hungry as they are,” said Chester Ng, general partner at venture firm Atomic, whose portfolio company Hims., launched in 2017, is going public via a Spac.

Insurance start-up Lemonade could have raised funding on better terms in the private markets, its CEO Schreiber believes. But the company still pursued an IPO. It priced below its last private valuation and saw a big first-day gain.

Being public has added some cost and distraction around stock volatility, Schreiber said. The biggest adjustment for the CEO has been the necessity to carefully word what he tells people about Lemonade’s performance. But “a few months in, we have no regrets,” Schreiber said.

Source: Private Equity News