Changes in IPO timing are good for early birds but a dice roll for others
Unicorns are landing, changing the investment landscape.
It is no secret that a bumper crop of unicorn initial public offerings is expected in 2019, as venture capital, growth capital, mutual funds and other investors seek to cash out of their private investments. Some 20 unicorns were in IPO registration at the end of the first quarter, according to the 2019 PitchBook-NVCA Venture Monitor.
Industry experts agree that these unicorns will be going public larger and later than venture capital-backed companies in the past.
That can be good news for early investors in a company as long as their stake maintains its weight. But how later-stage investors, including growth equity, private equity and mutual funds, will fare will depend on whether the public markets will match the unicorns' sky-high valuations in the private market.
On its first day of trading May 10, Uber Technologies Inc., a much-watched unicorn, saw its shares open at $42, about 7% below its IPO pricing of $45. Shares closed at $41.57, giving the ride-hailing service a market capitalization of $69.7 billion, less than its $76 billion pre-IPO private market valuation.
Managers with investments in Uber include SoftBank Group's SoftBank Vision Fund; TPG Capital's TPG VII Ultra Holdings; Benchmark Capital Partners' Benchmark Capital Partners VII and Benchmark Capital Partners VI; and Summit Partners, according to research firm CB Insights and Uber's SEC filings. Almost a dozen BlackRock (BLK) Inc. (BLK) funds also hold stakes, documents show. Another Uber investor is the Public Investment Fund, the sovereign wealth fund of the Kingdom of Saudi Arabia, SEC documents show. The Sovereign Wealth Fund Institute estimates the assets of the fund at $320 billion.
Limited partners face additional challenges, namely getting a spot in future, larger funds, if they don't already have an existing relationship with a venture capital manager.
Now that the money managers are returning capital from their unicorn exits, investors have to reinvest the money, said Kevin Campbell, Paoli, Penn.-based co-founder and managing general partner of private equity fund-of-funds firm Taurus Private Markets LLC.
For this reason, larger venture capital funds are not as open to very many new investors because existing investors want to increase their commitments to the manager's new funds, Mr. Campbell said. Before forming Taurus in 2018, Mr. Campbell had been managing director of private markets at DuPont Capital Management.
A 'ton of capital'
There are 18,000 venture capital-backed companies, including unicorns, said Jackie Kelley, Americas IPO Leader at Ernst & Young.
"There's still a ton of capital in venture capital and private equity funds" that is available to invest in these growing technology companies, Ms. Kelley said.
As of March 14, some $269 billion was invested in 326 unicorns, startups valued at $1 billion or more, said Chris Rust, founder and general partner of venture capital firm Clear Ventures. "That's a big number."
According to PitchBook, in 2018, 33 unicorns went public with a combined valuation of $76 billion. However, of the 77 unicorn IPOs launched between 2010 and 2018, there were only marginally more unicorns that had positive absolute returns since listing publicly than unicorns with negative returns, according to a PitchBook analysis.
Stock investors seem to be less enchanted with the story of many unicorns that are showing rapid growth but remain highly unprofitable businesses.
Some of the most watched unicorns including Lyft Inc., Uber and team messaging company Slack, have filed for or launched IPOs. While Slack hasn't priced yet, Uber's price was at the low end of its range and Lyft's share price has dropped from its IPO, data from CB Insights show.
"I think there needs to be an increased emphasis on achieving profitability," Mr. Rust said.
Even so, only 19% of the companies that went public in 2018 were profitable in the 12 months prior to their IPO, said Jason Thomas, Washington-based chief economist at Carlyle Group LP.
"That's the lowest percentage in history. The other low was 20% in 2000," he said.
Some unicorns may be going public because they are out of private market options.
But the problem for public market investors is that there could be adverse selection, Mr. Thomas said.
"Some companies that are going public may do so because they can't get private capital, either because they are too large, too risky, chronically unprofitable or some other factor," he said.
"Later-stage private equity tends to be more conservative. They are looking for companies with positive net income or close to it," Mr. Thomas added.
Therefore, the only choice for incremental capital or liquidity for some of these businesses may be a public listing, he said.
Despite the risks, unicorn exits are continuing to fuel a new bumper crop of supersized, multibillion-dollar venture capital funds. Even for later-stage investors that may not have made much money on the exit, a manager's association with big-name unicorn IPOs can boost its fundraising.
The same association can also help venture capital managers get access to and gain the confidence of entrepreneurs with whom they want to invest, industry insiders say.
The larger venture capital funds could have lower returns, said Kirsten Morin, Stamford, Conn.-based co-head of venture capital at Aberdeen Standard Investments.
"We think ... as fund sizes get larger, it's harder to deliver venture capital returns," Ms. Morin said. "A moderately sized fund of $500 million or less can get three times (its investment) if it captures a unicorn at its infancy," Ms. Morin said.
"If a fund is larger, the fund needs more hits and really big ones" to earn venture capital-type returns, Ms. Morin said.
Later-stage unicorn investors hope that the companies exceed the private market valuations when they invested, sources said.
"If you are coming in late and own a minority equity (interest in the unicorn) at exit, the returns do not move the needle," for investors portfolios, Ms. Morin said.
Exposure to unicorns has already enabled many venture capital firms to raise larger funds than ever before. According to Preqin, venture capital firms raised $79 billion in 2018, up 13% from the year before.
Due to these exits, distributions to venture capital investors have been strong, she said.
But larger fund sizes present additional challenges for investors going forward. It is not clear how many big wins the supersized funds have to capture to earn the return investors expect from venture capital, Ms. Morin said.
Venture capital firms "would have to have a larger ownership (stake in portfolio companies) or create a larger company," she added.