Venture capital executives will be watching the share price of Snap Inc., in coming months to see if unicorns really are magic.
They will be waiting to see whether Snap's share price stays above its IPO price — confirming its lofty valuation — or falls below. A large portion of the unicorn herd has reached the point of needing a capital infusion. There are typically three ways to get more capital: funding from a venture capital firm, growth manager, mutual fund or hedge fund; from a merger or acquisition; and from an initial public offering.
Asset owners also are keeping their eyes on Snap — the parent of Snapchat, the disappearing photo, video and messaging app — and waiting for their venture capital bets to pay off. Returns have been in a slump. The Cambridge Associates LLC U.S. Venture Capital index posted a 0.7% return in the quarter ended June 30, up from -3.3% in the first quarter of 2016. Venture capital returned -1.4% for the year ended June 30, the latest data available, on par with the Nasdaq's -1.7%. The annualized return for the 10 years ended June 30 was 13.2%, compared to 13.7% for the Nasdaq.
“The hope is that Snap's IPO will be the watershed moment that encourages other technology venture capital-backed companies to take the IPO plunge, said Kirsten Morin, senior investment manager, global venture capital, in the Stamford, Conn., office of Aberdeen Asset Management.
2016 was a bad year for venture capital-backed IPOs, with only 33 going public. Technology-related companies had a particularly tough year, with only 12 filing for an IPO last year, according to an Aberdeen analysis of Dow Jones data.
“Other companies are waiting to see how Snap trades,” Ms. Morin said.
Close to half of the estimated 154 unicorns — startups valued at $1 billion or more — need additional capital. Once a new company raises money, it typically lasts 18 to 24 months — and 49% of the unicorns are at that 18-month mark, Ms. Morin said, citing the Aberdeen analysis.
For many of the largest unicorns, a public offering could be the most viable exit route. Many — including Uber Technologies Inc., valued at about $68 billion; Airbnb Inc., at $30 billion; and Space Exploration Technologies Corp., at $12 billion — might now be too hefty to be swallowed up in a merger or acquisition, Ms. Morin said.
Asset owners with venture capital investments also will be closely watching the Snap IPO, she said. “Venture capital is all about the outliers. In order to generate top-quartile performance, investors have to be involved in companies in their early stages where there is a chance to produce alpha,” Ms. Morin said. “Single companies like Snap, Facebook or Uber will drive the returns of venture capital managers and limited partner returns.”
A number of venture capital firms have invested in Snap along the way. Some with the largest stakes are:
nBenchmark Capital Partners VII, managed by Benchmark Capital Management, with investors including the $1.6 billion Employees' Retirement Plan of Duke University, Durham, N.C.;
nLightspeed Venture Partners IX, managed by Lightspeed Management Co. LLC, with limited partners including the $44.4 billion Tennessee Consolidated Retirement System, Nashville; and
nGeneral Catalyst Group VI, managed by General Catalyst Partners, with LPs including Tennessee Consolidated and the New Jersey Division of Investment, Trenton, which manages investments for the $71.2 billion New Jersey Pension Fund.
Joining the audience watching Snap's shares are technology company executives. Last year was not a great year for technology exits in general, said Aftab Jamil, partner in the San Jose office of BDO USA LLP, a professional services firm providing assurance, tax, advisory and consulting services.
According to a February BDO survey of technology company chief financial officers, 31% felt that high volumes of mergers and acquisitions made 2016 a particularly poor year for IPOs, while 28% indicated poor IPO performance and 24% cited the slowing global economy. Survey respondents expect 2017 to be much better for technology companies, and two-thirds expect technology valuations to increase.
“Technology companies have had mixed results in going public and maintaining their high IPO valuation,” Mr. Jamil said.
Still, other unicorns are quietly getting ready to test the market, and many are backed by venture capital, he said. “Everyone is eagerly waiting to see what happens. Word on the street is that the Snap deal is oversubscribed.”
High-profile unicorns, including Airbnb, Dropbox Inc. and Uber, will be looking to take some direction from how Snap fares on the public market, Mr. Jamil said. “If the deal goes well and Snap prices at the high end of its range and the (stocks) are oversubscribed, it shows investor interest in technology company IPOs,” he explained. Snap was priced at $17 per share, higher than its expected price range of $14 to $16.
But it is important for private companies to maintain their IPO valuation because some with high valuations are not supported when they go public, Mr. Jamil said.
Take a loss
If the valuation isn't maintained, that would cause later-stage investors in Snap to take a loss. Benchmark Capital Management, Fidelity Ventures, General Catalyst Partners, Kleiner Perkins Caufield & Byers and Lightspeed were among the firms that provided Snap an estimated $538 million cash infusion in 2015, according to a private equity presentation to the California State Teachers' Retirement System by consulting firm Pension Consulting Alliance LLC.
“If Snap's stock price falls below its offering price, it would throw cold water on other IPOs, Mr. Jamil said. “These companies will not go public if it may erode investor value.”
In its first day of trading, Snap's shares closed at $24.48, up 44% from its IPO price. On March 3, Snap closed at $27.09.
While some shareholders might be able to sell their shares in the IPO, it is common for shares of insiders such as management teams and board directors to be locked up for six months. This makes it especially important for Snap to maintain its stock price over a number of months, Mr. Jamil said.
One factor that could hold Snap's share price down is the lack of profitability, Mr. Jamil said.
But an IPO is not the only way out for investors in some companies. Private equity firms are starting to buy venture capital-backed companies, Aberdeen's Ms. Morin said: “Private equity is becoming a viable exit for some companies. Private equity firms are flush with cash and are actively looking for acquisition targets.”
She declined to name the firms.
However, sources said private equity firms including Vista Equity Partners, Silver Lake, Thoma Bravo LLC and Bain Capital LP are starting to shop venture capital's stable of portfolio companies.
Some portfolio companies are taking a dual track, taking steps toward an initial public offering but also keeping open the possibility of a merger or acquisition, Ms. Morin said.
In January, AppDynamics Inc. — days before becoming the first tech company IPO of 2017 — accepted Cisco System Inc.'s $3.7 billion acquisition offer.
This article originally appeared in the March 6, 2017 print issue as, "Snap IPO filling investors with new hope".