Class of 2020 | cohenjas@wharton.upenn.edu
Just two years ago, 117 venture-backed companies had IPOs totaling $15 billion in offer amount. However, in the first two quarters of 2016, there have been just 18 IPOs totaling less than $1.5 billion. This trend is largely a symptom of CEOs’ eagerness to remain private as long as possible as a means of focusing on long term growth without short term scrutiny. Unfortunately for venture funds, when companies with large valuations avoid IPOs, exits via M&A become more difficult and it is harder to return capital to investors.
On September 30th, California-based Nutanix, a cloud-based software company for enterprises, became the largest venture-backed tech IPO of the year. In its first day of trading, Nutanix’s valuation increased 130% to over $5 billion from $2.2 billion, the largest first-day stock jump for any company in over a year. With $400 million in backing from funds such as Khosla Ventures, Lightspeed Venture Partners, and Fidelity Investments, 7-year-old Nutanix has gone up against companies such as Cisco and VMware in its effort to educate the market in spreading its new form of data storage—hyperconvergence. Nutanix has been successful so far in reaching its audience with clients such as Best Buy, eBay, and Honda.
Nutanix reached this point by following Silicon Valley’s favored growth model—raise money, use the money to expand, and raise more money. Nutanix is losing hundreds of millions of dollars and yet, until their IPO, they were one of 149 private companies valued at over $1 billion. However unlike most of those companies, they are on a clear path to profitability with huge year-to-year growth in revenue, and the trend on Wall Street has been a desire to invest in profitability. With positive growth and a trend pointing towards profitability, Nutanix felt confident going public and the market responded in an overwhelmingly positive way.
So why are there so few IPO’s from Silicon Valley unicorns ($1 billion or more valuation)? Primarily, the public market simply values these companies lower. This can be for a multitude of reasons, but largely is because of the increase in nontraditional investors, such as hedge funds, and because of the dilution that preferential shares from private investments induce. Put simply, privately owned companies are valued higher than publicly owned companies, and have no incentive to go public at a lower valuation. This also affects M&A because other companies do not want to pay an inflated price. So what happens? Companies like Uber and AirBnB remain private for as long as possible, and investors have to be patient. When investors cannot get their money back, they cannot make new investments. This is not a good cycle to be in.
Will Nutanix’s wildly successful IPO break this cycle and promote an increase in venture-backed IPOs? Not necessarily. Of course, a successful IPO will force other unicorn companies to reconsider their options and the viability of going public. However, the market is still wary of the numerous failed IPOs just this past year. The idea of risking a down round when going public as opposed to raising more money while staying private is still not attractive to CEO’s, even when there is a chance for more long-term success. As much as companies are eager to follow in the footsteps of Facebook and Twitter, they are still afraid to take the leap. Snapchat is, to a certain extent, breaking that trend. Eyeing an early 2017 IPO, Snapchat has not yet developed into a company with a clear long-term value, and several features, such as their popular “Stories” feature, have been copied by platforms such as Instagram. As much as Nutanix is an interesting case study in the accommodation of the public market to unicorn IPOs, Snapchat’s IPO may provide more insight into whether the negative trends will continue in the long run.