When talking about market valuations, there is a major difference in the approach that a VC firm will take when evaluating public and private companies. It is largely due to the major differences in available information between the two companies.
Unfortunately, determining value can be difficult with the recent glut of hyper growth start-ups. A valuation for a private or public company follows similar mathematical procedures, but private companies often do not disclose key financial information. That said, the mind-boggling valuations over the past five years are more indicative of the markets than the true value of the company itself.
In our own firm, Manhattan Venture Partners, we recently discussed the tension that lies between public and private market valuations in an article entitled “ The Difference a Month Makes” from our monthly “Venture Bytes”. We as a private company were lucky to not to experience some of the trials that public companies experienced towards the end of 2015 and begining of 2016. Here is a short excerpt from that article offering valuable insights into this public vs private market valuation discussion.
The fading weeks of 2015 and the first weeks of 2016 were very difficult in tech. Markets sold off, down rounds, downgrades and share price sliders were the order of the days, weeks and months. It was down right down out there and private tech was not spared. We are outside the public markets and outside of the public market spotlight. However, IPO’s were put on ice, mutual fund downgrades caused some to panic. We stayed the course, of course. March was far kinder to risk, oil, tech and private shares as well. Now we have the twin opportunities to take stock and factor lessons going forward.
For many investors in private, pre-IPO technology the recent return of fear was overdue and taken in stride. However, the growth in late stage start-ups and the increase in late stage start up investing have changed the volatility and attitudes in the market. We saw large slides in the public company comparables that many use to judge the valuations of pre-IPO firms. These slides and a widespread sense of overdue draw down in valuations, combined with jitters driven by recently expanded ranks of private technology investors, created a partial swoon. This allows us a rare and valuable chance to look back and learn from a stress test.
Late stage private firms are more vulnerable to public market conditions than earlier stage firms. This arises because the comps from public companies weigh in valuation decisions and talk of IPO is always close. These firms are not hurt directly and there is no necessary, not even a likely, effect on their business or growth rates. All that changes is the multiples enjoyed by the public comps and the market’s sense of the size of the opening in the IPO window. Lately, that has been enough to create dislocation, correlation and concern.
We see the recently increased concern coming, ironically, from the growing size of late stage preIPO valuations and a change in the types of holders of shares. As more retail investors have entered the space, less specialized and experienced holders of shares have come to own more shares.
Many have entered through investment vehicles and a growing number own exposure through mutual fund positions. These owners see private shares largely as one among many types of shares that they own. Thus, rising general fear and falling share prices raise the prospect of selling. The relatively more involved and expensive process of selling private shares creates anxious feeling and sometimes complaint. This rankles holders of shares and increases regulatory pressures to write down shares, further rattling nerves.
What have we started to learn? As private markets have grown and valuations increased, a broader and less specialized class of investors has entered the space. As the recent stellar run, over 6 years old, sails into rougher seas, we see that the growth in the space has changed the role of public markets. Newer owners of pre-IPO tech have proven more likely to assume correlation with public shares and to mark portfolios accordingly. As private shares continue to grow and emerge as an asset class, the correlations between public and private share price movements appears to be growing. In the short run that is encouraging. In the longer run, that is good to know.
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