For startup founders, more money can buy more of their most valuable commodity — time.
On April 15, 2015, VC firm New Enterprise Associates (NEA) announced the raising of a new fund totaling $3.15 billion. The fund is split into two parts — a $2.8 billion main fund and a separate $350 million fund for late-stage investments.
NEA’s initial investments usually originate in the early stages of the startup lifecycle, at the Seed, Series A, or Series B funding rounds. Like many firms, after that initial investment, they invest, as needed, as the company grows and scales. However, they invest aggressively as not to lose equity shares as the investment lifecycle moves into later rounds.
“Over time, unlike a smaller fund, with a larger fund we can maintain, if not increase, our ownership of companies as they grow,” said NEA partner Jon Sakoda.
Smaller funds tend to back off of their pro rata investment in follow-on investments, which means their equity share gets diluted as additional rounds happen. But, NEA has always maintained or increased their investment in order to maintain or increase their share.
The size of the latest fund raised by NEA (its 15th fund) is indicative or more than just the firm’s investment strategy. Startups, as a whole, are staying private for longer periods of time. This means that valuations are getting larger and follow-on investment in the later stages carry a higher price tag. It’s part of the reason why NEA raised its fund as two separate vehicles.
“The most exciting thing right now, for us, is the companies aren’t desperate to sell,” Sakoda said. “I think everyone looks at M&A as an extremely attractive way to create liquidity, and it can be. But, I think you’re seeing a lot of the best companies, and the ones that have the most disruptive technology decide to go it alone.”
For example, take a look at self-destructive messaging app Snapchat. The company was recently valued close to $20 billion dollars. It has almost any exit option a tech company could want, but it hasn’t mentioned any plans for an IPO or an acquisition.
The obvious question is why? Why are startups staying private for longer? Brian O’Malley, a partner at Accel, said that understanding this recent trend starts with understanding why companies went public in the first place.
Historically, he said, IPOs helped startups do three things:
- Raise capital
- Provide liquidity
- Announce that the company had “arrived” or “made it.”
Nowadays, O’Malley said, it could be argued that all three of those things are easier to do as a private company. Ten years ago, companies had far fewer options, especially in terms of raising capital. Companies couldn’t access capital so they had to do an IPO or get acquired to keep moving forward.
But, as some would say, money is “cheap” now and there is expanding capital in the private market.
“There seems to be expanding pools of capital for private companies to the point where people are even criticizing the fact that people are raising as much money as they are in the private market and staying private longer,” Sakoda said. “I think that it’s an unfair criticism to say that companies shouldn’t stay private longer.”
In addition to expanding capital through VC investments, other forms of financing are also more readily available. According to Hired CEO Matt Mickiewicz, debt financing and other forms of non-equity financing are cheap and easy to find now too.
There’s been a culture shift in the startup world. There’s not a lot of pressure anymore to take companies public, and it’s not necessarily cool to sell.
“Ten years ago, being acquired by Google was the dream for a lot of entrepreneurs,” Sakoda said. “I’m not sure that’s the case now. I’m not sure that people say ‘my dream is to be acquired by a Google or a Facebook.'”
In some ways, the life of a startup founder is easier if the company remains private. Ultimately, you have fewer people to answer to and more control of your vision.
On the financial side of things, you don’t have to deal with quarterly meetings or earnings reports, and your worth is calculated differently than that of your public counterparts.
“You don’t have a number that you have to look at everyday that you’re being judged on, namely your stock price,” Mickiewicz said.
After understanding the why, we have to look at how this trend shapes the startup market. Primarily, it’s contributing to high valuations.
Last year, this was exemplified by Facebook’s $19 billion acquisition of WhatsApp, which made headlines around the world. It was the premier piece of evidence that startup valuations are at a level previously unheard of in the tech space.
“If you look at the initial market caps of Microsoft, Yahoo, Google, and Amazon when they went public, those companies, for the most part, went public when their valuations were less than one billion dollars,” Mickiewicz said. “That’s almost unheard of now.”
These increasingly high valuations can be great for the founders of the companies themselves, and we’ll likely see M&A outcomes getting larger and larger as the years roll on. That’s good for the founders and investors alike, but these high valuations can prove dangerous as well.
Access to more capital means startups can get going earlier and have more time to get things right, O’Malley said. However, it can draw out the time it takes to get liquidity and keeps investors more tied up in the health of the market. Still, that’s not necessarily a bad thing, O’Malley said, as everyone can stand to be more successful in a bigger deal.
If a founder does decide to do an IPO eventually, though, staying private for longer can present other challenges as well, especially when it comes to over valuation.
“For example, with the Box IPO, the company went public below the price of its last private market valuation, so there’s pros and cons to waiting that late,” Mickiewicz said. “Not everybody is going to be a winner.”
There are both risks and rewards when it comes to a startup holding onto its startup status for an extended period of time. While it affects the startup founder and investors heavily, O’Malley said that the employees of the company should also be considered.
“The real group that I worry about are the employees of these companies,” O’Malley said. “Venture firms are set up for the long haul and have the benefit of a portfolio. Founders are getting money handed to them to “take chips off the table” and diversify. Unless the company reaches truly massive scale, employees can be left holding the bag while their leaders cash out and delay an IPO. If a company is going to stay private longer, it is critical for boards to look out for those not at the table; the people grinding away turning an idea into a reality.”