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Tech, IPOs and Unicorns: Too much money is a good thing, isn’t it?

14 November 2018 #Information Technology #Entrepreneurs & Start-Ups

The tech sector is booming. We live in a time of the mega private business in which the likes of Uber and Airbnb are extending their lives as privately held businesses by delaying public offerings. The venture capital asset class is more buoyant than ever and now includes atypical investors such as hedge and sovereign wealth funds who seek a piece of the action. Governments globally are also trying to attract innovation and tech talent using all manner of inducements, from tax breaks to immigration. So, are we living in the golden age of tech or is the frothy venture capital market a sign of a bubble reminiscent of that which led to the dot com bust of 1999/2000, and why does this matter to entrepreneurs? 

One could be forgiven for believing that the current froth is a clear sign of a bubble. Investors, for example, are more open than ever to backing loss-making businesses in the public markets. Of those businesses which have decided to take the IPO plunge, recent statistics paint what some would consider an alarming picture. According to data compiled by University of Florida Professor Jay Ritter, 83% of IPOs in the first three quarters of 2018 had negative earnings. This is the highest proportion based on Ritter’s data going back to 1980, including in 1999 and 2000 when 76% and 81% of IPOs had negative earnings respectively. In addition, a study released earlier this year by the US National Bureau of Economic Statistics suggests that private market valuations of tech unicorns are up to 50% overvalued.

Granted, the referenced data above is exclusively American and do not relate directly to entrepreneurs navigating their businesses through the earlier stages of their lifecycles. However, they do provide a relevant barometer for the direction of global markets which have of late enjoyed a bull run and in particular offer some key learnings for early stage entrepreneurs.

For entrepreneurs at the beginning of the funding journey, the clear advantage of a buoyant venture capital market is that it takes away the distraction of fundraising for management teams and affords businesses the flexibility of staying private for longer, bypassing the scrutiny and administrative burden that comes with being a listed entity. However, entrepreneurs and their management teams should be acutely aware that they do not become complacent in the midst of this investor demand. The overall aim of business remains to turn a profit and increase shareholder value; raising money simply because it is forthcoming or for the sake of achieving a higher valuation is not a panacea. Situations where founders and early investors of highly valued venture-backed businesses see no return on exit are becoming increasingly common. The phenomenon is not surprising given the onerous terms of later stage investors who are of course wise to valuation risk.

The stakes are of course high for entrepreneurs and their shareholders, but entrepreneurs also have a fiduciary duty to maximise their shareholders’ wealth. Unfortunately, raising money imprudently can do just the opposite.

Zafar Kanani 
Forbury Investment Network 

This information is for guidance purposes only and should not be regarded as a substitute for taking legal advice. Please refer to the full General Notices on our website.

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