The golden age of the unicorn is over. And that’s a good thing. Because average investors have been shut out of getting in on early gains as excesses have gone unfettered.
True there are still 413 private companies in the world worth over a billion dollars, including a few hotties like Airbnb and SpaceX, never mind WeWork, once worth $47 billion but now humbled with a valuation of a mere $8 billion, (in itself a poster child for the end of an era.)
Fact is though most of the trophy unicorns have jumped the IPO fence. Snapchat (SNAP), Uber (UBER), Lyft (LYFT), Spotify (SPOT), Pinterest (PINS), Peloton (PTON), Beyond Meat (BYND), and Slack (WORK), they’re all public ponies now and for the most part, rather lame ones at that.
But while public shareholders in these companies are reeling after abysmal post-IPO performance by these companies (yes, they may work in the long run), at least one group of investors is still riding tall. I’m talking about the VCs, particularly the Silicon Valley variety. Camped out along Palo Alto’s Sand Hill Road with their Stanford pedigrees, Patagonia vests and $10,000 Pinarello bikes, these (almost all) guys have never been better.
The VCs you see, got in early and made a mint. Actually, back in the day I’d have no problem with that. VCs risk their own capital, and many of their bets don’t pan out. If they get rich, good for them.
That’s the way it’s been since at least the 1970s when early venture firms like Kleiner Perkins and Sequoia Capital (founded by Don Valentine, who recently passed away), ponied up to invest in the likes of Apple, Oracle, Cisco, Google and their ilk. VCs funded these companies for a few rounds, the companies went public, and then ordinary shareholders, aka, you and me, rode the stocks—sometimes to the moon.
Except things are different now. Start-ups stay private much longer, sucking up billions of dollars of investment capital and yes becoming unicorns.
And therein lies the problem.
What’s happened recently is that by the time these companies go public, they’ve already run through much of their high growth. Instead of the VCs (and some others—more on that in a minute) getting some of the upside, they got most of it. And not only that, increasingly when these companies do go public, they’re still losing massive amounts of money. Often they have two (or more!) classes of stock—leaving public shareholders without voting control or say in governance. And even in a few cases, we’ve seen dubious side deals with executives. (Can you say WeWork?)
Uber’s ride to an IPO
At this juncture, a closer look at Uber’s financing history, tracked on Crunchbase might prove fruitful. Between its founding in 2009 and the IPO this past May, Uber did a staggering 24 rounds of financing (including a $200,000 seed investment by co-founders Travis Kalanick and Garrett Camp.) The list of investors is eye-popping, a roll call of companies and individuals from around the world. Early rounds are highlighted by a who’s who of Silicon Valley VCs and their firms, along with some other bold-face names. A sampling: Sean Fanning, Chris Sacca, Mitch Kapor, Jeremy Stoppelman, Jason Calacanis, Gary Vaynerchuck, Zack Bogue, Alfred Lin, Troy Carter, Sequoia Capital, Benchmark, Bill Gurley, Menlo Ventures, Shervin Pishevar, Jeff Bezos, Matt Cohler, Sean (Jay-Z) Carter, Kleiner Perkins, John Doerr and many more.
The best way to think about this list is, they got in when you couldn’t.
And that’s just the venture crowd. After that comes a layer of Wall Street investors; including Goldman Sachs, Fidelity, BlackRock and Wellington, followed by international investors including the Saudis and Softbank, and corporations such as Microsoft and Toyota.
Last one in the boat was PayPal which invested $500 million in Uber at a valuation of $78 billion. Today, Uber’s market cap is $48 billion. But PayPal is hardly the only investor underwater. It’s likely that the last 11 of the 23 rounds of investors are all in the red including Tata, Tencent, Axel Springer, and many others.
Even VCs see the danger in all this. “[The current IPO environment] takes the growth opportunity away from regular people and puts [it] all in the hands of the economically elite” says Ben Horowitz, cofounder of venture capital firm Andreessen Horowitz. “And that's a terrible problem.”
No wonder the number of public companies has been cut in half to around 3,600 since 1997, though that decline has stabilized recently.
A question: How did we get here?
A little history to explain. In response to the Great Crash of 1929, Congress and the Roosevelt administration created the Securities Act of 1933 and Securities Exchange Act of 1934 and the Securities and Exchange Commission to both define and regulate public companies. Decades later, in the wake of scandals at Enron and WorldCom and others where investors lost billions, Congress passed the Sarbanes-Oxley Act, which created strict new rules for accountants, auditors, and corporate officers and imposed more stringent record keeping requirements. And then in 2012 came the Jumpstart Our Business Startups Act (JOBS), signed by former President Barack Obama, legislation designed to make it easier for small companies to raise money and go public, but paradoxically also raising the trigger to go public from 500 shareholders to 2,000 shareholders.
‘Dangerous and difficult’ to be a public company
Allowing private companies to have more shareholders makes it easier to stay private longer. And VCs and CEOs say Sarbanes-Oxley and other costs have made going public less appealing (though some dispute this.) “The whole regulatory structure of being public has just made it such that it's very dangerous and difficult for a small growth company to be a public company,” says Horowitz who also noted onerous insurance costs and illogical disclosure requirements.
No wonder companies stay private. And there are other factors at play as well. “I think the decline [in public companies] is largely attributable to the fact there are so many more types of investors that are willing to invest in private companies compared to say 10 years ago,” says Anna Pinedo, a partner at Mayer Brown who specializes in securities law.
The amount of money that has flooded into venture capital from the likes of the aforementioned non venture Wall Street firms for instance, which until recently hadn’t been in the venture game, has been stunning,
In 2018 for instance, private investors poured $130.9 billion into technology and biotech companies, far outpacing the $50.3 billion raised via IPOs and follow-on offerings, according to Jane Leung, chief investment officer at Scenic Advisement, continuing a trend that has existed for the past decade. And institutional investors say they will continue to increase their allocation into venture and other private markets.
Jay Ritter, a finance professor at the University of Florida who studies IPOs, sees another factor: “Mergers are actually the main reason for the reduced number of IPOs, lots of small growth companies rather than growing organically, and going public and remaining independent, are instead selling out to big companies.”
Yup. Earlier this year I calculated that Apple, Facebook and Google alone had bought 500 companies over the past few decades, most of them recently.
‘What we're left with is just a lot of debt, no equity, and no cash flow’
But even beyond the lack of investment opportunity, Alicia Levine, chief strategist at BNY Mellon Investment Management, raises an additional effect all of this may be having on our economy and society. “The flood of free money over the last 10 years has funded companies that call themselves tech companies but are actually being fueled by tech to disrupt existing businesses, whether it's in retail, whether it's exercise, whether it's hair and makeup, whether it's taxis,” she says. “So you have these companies with massive debt calling themselves technology companies, disrupting actual businesses with equity and cash flow. And what we're left with is just a lot of debt, no equity, and no cash flow.”
It’s fine if these new companies ultimately succeed but if they fail, they may have destroyed real world companies and the jobs that go with them, along the way.
So net net, what does this mean? Well it means many high-potential companies are either bought up by the tech giants or stay private so long that a significant portion of their best growth phase is captured solely by an elite class of investors. And furthermore, it could be that massively funded private companies, some of which may not survive, are destroying healthy businesses and jobs.
What does SEC Chairman Jay Clayton have to say about all this? The SEC wouldn’t comment on the record, but one might imagine it would say something along the lines of, capital formation has been a focus of the SEC under Clayton’s leadership and one which he has publicly addressed often. True he has, but what about action?
To be fair it’s tricky because for the most part, no one has violated the letter of any laws here. But what about the spirit on the law? That Joe Q Public should have fair access to investments that Joseph Rich Guy has? That if a company has nearly all the benefits of being a public company, that it needs to play by public company rules?
For better or for worse, some of these problems may be less pressing now. The most extreme excesses in the system exhibited by WeWork et al, look like they are self-correcting. And the now-public unicorns may prove me wrong and become great public investments over time. To that era, good riddance.
Think about it. We allowed for the unfettered creation of a class of companies named after a symbol used as fantasy, to enrich a select few and undermine the investing public.
This shouldn’t be business as usual in America. It should be an aberration.
This article was featured in a Saturday edition of the Morning Brief on November 9, 2019. Get the Morning Brief sent directly to your inbox every Monday to Friday by 6:30 a.m. ET., Saturdays by 8 a.m. ET. Subscribe
Andy Serwer is editor-in-chief of Yahoo Finance. Follow him on Twitter: @serwer.