The unicorn dilemma–VCJ cover story


Lynda.com made news this spring when LinkedIn purchased it for a hefty $1.5 billion. VirtuStream turned heads a month later when EMC announced a $1.2 billion buyout with the goal of expanding its cloud capabilities.

What’s perhaps most notable about the two deals is that there aren’t more of them. As many as 100 unicorns roam the venture landscape, but exits are down this year, and high valuations may be playing a significant role.

This is true not just of M&A, but also public offerings.

Last year, 15 venture-backed tech companies launched IPOs on U.S. exchanges that as of press time had unicorn-sized market capitalizations above $1 billion. Just four met the criteria so far this year, including Fitbit’s June offering.

The slump should sound alarm bells for the venture capitalists and crossover investors who pumped billions into richly valued private companies hoping to disrupt markets from transportation to education to hospitality. The path to exit for this unprecedented bumper crop of unicorns may be longer than many backers intended, and the industry’s recovery more at risk than many want to admit.

Should the shift continue and distributions slow, LPs could find themselves rethinking new fund commitments and advocating more loudly for GPs to harvest their successes at any price. Investors in turn could rein in startup burn rates and, in the worst case, contemplate down rounds for companies on all but the fastest growth trajectories.

The M&A market may be the biggest point of worry. That’s because it is easy to forget during a period with a relatively open IPO window that for every venture-backed company completing a public offering from 2000 to 2013, nearly seven others exited by acquisition.

Also of note is that the present slowdown in big-ticket privately backed tech deals runs against the grain of relatively strong acquisition activity in the United States, including for public companies in technology and healthcare. Big corporate acquirers know they need the innovation startups can bring, but high multiples and premium prices appear to be making them queasy.

“We’re seeing the early signs” of this already, said Ron Lissak, a managing partner at the investment bank Catapult Advisors. “The buyers are exercising more discipline.”

So far, this year’s numbers are discouraging. Overall technology M&A continues to be solid in the United States, with deals up a 36 percent last year and deal value leaping an astronomical 62 percent. Billion-dollar transactions more than doubled during the period, with SAP buying Concur Technologies, Avago Technologies acquiring LSI, and Oracle corralling Micros Systems.

Among private venture- and PE-backed tech companies, six billion-dollar-plus transactions took place, led by Facebook’s $22 billion acquisition of WhatsApp and Google’s $3.2 billion takeout of Nest Labs, according to data from Thomson Reuters. Unicorns Oculus VR and AirWatch also were targets.

Another three deals barely missed the mark. Twitch Interactive, Ebates, Shopping.com and Dealer.com sold for between $970 million and $993.7 million each, according to Thomson Reuters. That adds up to nine deals close to or above the billion-dollar mark.

This year, public company activity in the broad tech market has kept pace. Intel announced a $16.7 billion purchase of Altera, Avago Technologies agreed to buy Broadcom for $37 billion and Hewlett-Packard closed on Aruba Networks.

However, megadeals involving private companies declined sharply. Through early June, just two transactions have taken place this year: Lynda.com’s takeout and Raytheon’s acquisition of PE-backed Websense, the Thomson Reuters data show. A third deal, the Virtustream acquisition, was announced in May and hadn’t yet closed at press time.

The pullback is more dramatic in the U.S. IPO market. A total of 26 venture- and PE-backed tech offerings reached the market in 2014 that as of mid-June had market caps above $1 billion, according to analysis of the data. The 15 unicorns in the total include LendingClub, Mobileye, GoPro, GrubHub and Hortonworks. Another six of the deals came from China and the final five were PE-backed or spinoffs.

Activity has fallen off this year. Five deals have come to market that at press time held market capitalizations above $1 billion, a 81 percent decline. Included are four unicorns: Etsy, Box, Shopify and Fitbit.

Numerous factors beyond price help explain the decline. For one, plenty of money remains available for private-market late-stage rounds, the so-called private IPOs, where unicorns pocket enough cash to support themselves for years. Entrepreneurs with top companies know they can win attractive valuations and retain the freedom to remain private.

Cloudera and Domo, for example, both raised well ahead of their needs, taking on hundreds of millions of dollars and saying, in effect, they will survive no matter what the economy does in the period ahead.

Many of the companies genuinely believe they can accomplish a great deal on their own without the benefits of an IPO by acquiring customers though online distribution and building a global footprint.

“There is a psychology going on with entrepreneurs, teams and investors that they can build the next billion-dollar business,” said Ryan Floyd, a managing director at Storm Ventures. “People don’t need to be sellers.”

This story first appeared in affiliate magazine Venture Capital Journal, which is published by Buyouts Insider. Subscribers can read the full story and accompanying tables by clicking here. To subscribe to VCJ, click here for the Marketplace.

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