Falling valuations in private markets starting in the latter part of 2015 and continuing into early 2016 have set off a shift in the way late-stage venture-backed companies are operating – in a good way.
Until recently, so-called unicorns could raise nearly endless amounts of capital at highly attractive valuations. In fact, in many instances, late-stage private market valuations exceeded subsequent public market valuations, as investors bet that these companies would grow into those premium values. Meanwhile, the availability and low cost of capital allowed companies to continue to finance their growth plans while remaining private and independent. Top line growth was first priority, while profitability and, in some cases, operational discipline, took a back seat.
Private Company Median Valuations
Since the correction, however, some of the most active late stage/pre-Initial Public Offering investors have become far more valuation sensitive or have retreated from the market altogether. A very small number of unicorns are able to raise money at lofty valuations, but this is a “flight-to-quality” as investors seek out only the most disruptive and proven of the unicorn herd. These are now the exception, not the rule, as most unicorns will have a very hard time maintaining their last round valuation.
Now that valuations are falling for all but a few, unicorns which were not already profitable (the vast majority of the ~150+) are racing to demonstrate the profit potential of their business model – or better yet, to actually achieve profitability. Many of these companies have raised enormous piles of cash – proverbial war chests – to finance this mad dash to profitability, so the inevitable thinning of the herd will take some time.
Several missteps at high-profile companies such as Zenefits, Theranos and others1 have also fueled Venture Capitals' and entrepreneurs' renewed focus on operational discipline. Many of these private, venture-backed companies have become quite large and complex, operating in highly dynamic, occasionally regulated industries, so the newfound focus is overdue and entirely appropriate. A more rational late stage market, driven by business model fundamentals, makes for a more sustainable long-term venture capital ecosystem.
Securing unicorn status is not a guarantee of success
In the meantime, the falling costs of technology continues to fuel an exciting cycle of innovation. Many non-tech segments of the economy are only just beginning to be disrupted by technology (education, healthcare, transportation, to name a few) while advancements in artificial intelligence, machine learning, virtual reality continue to open new avenues of exploration.
We have no doubt that the next generation of unicorns will be just as transformative as the current generation.
1 Companies mentioned are for illustrative purposes only and are not intended to be a recommendation to buy or sell any security.