There’s a Wave of Pandemic-Era Pre-IPO Startups Stuck in Limbo Right Now – Business Insider

Late-stage investors want to wait for their portfolio companies to “grow into their valuations” rather than push them public and book a sizable loss in the process, according to PitchBook’s Q3 report on the IPO market. If they sit tight, the idea is that a company will grow into its large valuation and investors will recoup cash.

But revenue growth at most startups has also slowed, meaning valuations will take even longer to achieve – and some may never come to fruition, according to the report’s author and PitchBook analyst James Ulan.

For example, buy-now-pay-later firm Klarna saw its valuation plunge to $6.7 billion after raising at $45.6 billion a year prior.

“You have to promise the moon, otherwise the valuation is even more crazy,” Ulan said of Karna’s late-stage rounds. “And it just turns out that you can’t grow that fast for a long period of time.”

The days of seeing 80% to 100% year-on-year revenue growth are gone, Hussein Kanji from early-stage fund Hoxton Ventures told Business Insider.

A good enterprise software company will grow 40% in this market, while 50% would be exceptional, he said. “A lot of them are guiding to 20% to 30% growth,” he added.

Startups can hold on to their price tags while there is plenty of cash in the bank but, eventually, money will run out and they will look for fresh funds. Most unicorns have less than two years of cash runway, according to a Q3 Morgan Stanley report, while the desire to hold onto legacy valuations has led to hidden and unannounced deals where valuations are usually flat to down, said PitchBook’s Ulan.

One way to avoid haircuts is to introduce structure to deals, said Hoxton’s Kanji. Various terms can be added to financing deals that allow startups to access fresh funds and keep large valuations but protect investors if the company flounders. This, however, disadvantages earlier investors because structure can “eat up economic returns” when there is an exit.

Structure doesn’t hold when a company goes public, meaning it could push some pre-IPO companies to M&A. However, it doesn’t make sense for big tech companies to gobble up unprofitable startups when their own growth has slowed too, Kanji said.

“So you have this wall of unicorns that are not going anywhere – they’re not getting acquired, they’re not getting IPO’d,” Kamil Mieczakowski, partner at software fund Notion, said.

“Maybe they shouldn’t have ever been called unicorns in the first place, right?”

Investors tend to assess whether a company is IPO-ready on the rule of 40, which is revenue growth plus EBIT margin. The Morgan Stanley report noted that only around 150 companies out of 1,200 private unicorns “actually have a rule of 40 that you would be looked at favorably by the public markets.”

Funds holding their position, at current growth rates, could be waiting for five years inside a typical 10-year fund, which could have already been three years into the cycle at the point of investment.

“So that’s like year eight before you get parity,” Kanji said.

“They should be drawing a line in the sand and saying, ‘we’ll just get rid of these things’ or ‘we’ll forget about them and close that chapter or sell them off at a discounted price and move on.’ But it’s really hard, emotionally, to do that.”

Indeed, some investors will cut their losses after already doubling down over the past two years. Bankruptcies “are kicking in” with companies that can’t secure funds and lose investor support, said Fabian Heilemann, CEO of impact fund Aenu.

Graphcore, touted as an AI chip rival to Nvidia, is one such startup rumored to be up for sale after Sequoia wrote off its stake last year.

Kanji added: “This is a lesson for a lot of people – if the IPO window opens up, take the company public.”