A long time ago in a galaxy far, far away called Silicon Valley, Unicorns and the mighty Decacorn roamed the land. These species were a colossal force to be reckoned with.
While a handful of these creatures displayed growing revenues and high margins, many of them exhibited scary features such as pre-profit (even pre-revenue) and excess capital burn.
They were so powerful that there was a belief that they could raise more capital being privately held vs. publicly traded.
Things all changed on an apparently normal, mildly temperate day. Out of nowhere, the evil Grandma Yellen traveled via Greyhound through the heartland and rained down interest rate hike after interest rate hike, as if giant asteroids were hitting the Earth.
These confounding hikes were too much to withstand for the Unicorns and Decacorns who fell by the wayside and disappeared…
Okay, enough fairy tales.
I’m of the vehement belief that ZIRP and historically low interest rates were gigantic factor in these companies gaining +$1B valuations.
Two reasons: money was (still is, but its rising) extremely cheap which allowed easy access to credit, and a seemingly everlasting low yield environment that encouraged excessive risk taking.
Seriously though, how many companies can “change the world?” You’re telling me an app that can find the cheapest grilled cheese in downtown Chicago is worth a cool billion? The f#*k out of here.
It should come as no surprise that there has been a drastic reduction in amount of headlines or news stories about SnapBox raising $275M or DropChat being valued at $19B.
Instead, the dreaded “down-round” phrase has been thrown around and associated with these SanFran darlings.
This past October, BlackRock, which led a $350M deal that more than doubled Dropbox’s valuation, cut its estimate of their valuation by 24%. In November, Fidelity wrote down its stake of Snapchat by 25%. Oh yeah, they also wrote down Zenefits (HR platform) by 48% and Blue Bottle Coffee Co. by 43%.
Don’t get me started on the court jester display that Theranos has put on over the past three to four months. Further, deteriorating conditions in public markets and smarter big money players are confirming this trend. Tech IPOs are at 20 year low.
According to Renaissance Capital, only 23 of 169 IPOs were from tech. More worrisome, these tech IPOs have raised a total of $4.2B in 2015, shockingly lower than the 55 tech IPOs that raised $32.3B in 2014.
Box and Square, while taking a line drive to the nuts, went public this year at values substantially lower than their last private valuation, 30% and 40% respectively.
Finally, the ever egregious “liquidation preference” clause that VC’s, founders, and board members include in their preferred equity shares just screams slippery slope. Often, the owner of this equity class gets a guaranteed return of at least 1x their investment.
What does this mean? Imagine Fred Wilson, skipping and frolicking, buys 20% of the above mentioned grilled cheese app company for $200M (said company is now worth $1B), with $1 per share and 1x preference. Also, there is the factor whether the shares are participating or not.
Compare the two situations below:
| Sale Price: | $ 1,500 | (in $millions) |
| Preferred and Participating | Preferred, but Non- Participating | |
| Preferred | $ 460 | $ 300 |
| Common | $ 1,040 | $ 1,200 |
| Sale Price: | $ 600 | (in $millions) |
| Preferred and Participating | Preferred, but Non- Participating | |
| Preferred | $ 280 | $ 200 |
| Common | $ 320 | $ 400 |
Don’t get me wrong, there are plenty of viable, awesome, and disruptive Unicorns and new IPOs. Uber, Xiaomi, Airbnb, Palantir, Snapchat, and Pinterest come to mind under the privately held umbrella, and the recent IPOs of Pure Storage and Atlassian are very attractive long-term investments.
Factors such as ridiculously elevated valuations, low barriers to entry, and heavy competition are just a few challenges I see for these Unicorns. I plan on analyzing these companies next year, and providing a reasonable valuation.
In the end however, with Yellen halting easy monetary policy and cheap capital, I highly suspect that this will have a major negative impact on these companies. VC’s and other investors will pull back on reaching for yield.
In an ironic and perilous similarity of circumstances, the Fed aggressively began raising interest rates by a quarter point, beginning in June of 1999 through December 2000. Anyone remember something bursting during that time?
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