Thursday, April 21, 2016

Venture Capitalist Bill Gurley: "Why the Unicorn Financing Market Just Became Dangerous…For All Involved"

Bill Gurley is a General Partner at Benchmark Capital. He has raised some eyebrows (and blood pressure) among the Sand Hill Road gang with straight talk on the VC biz. Here's more.

From Mr. Gurley's Above the Crowd blog:

On the Road to Recap
In February of last year, Fortune magazine writers Erin Griffith and Dan Primack declared 2015 “The Age of the Unicorns” noting — “Fortune counts more than 80 startups that have been valued at $1 billion or more by venture capitalists.” By January of 2016, that number had ballooned to 229. One key to this population growth has been the remarkable ease of the Unicorn fundraising process: Pick a new valuation well above your last one, put together a presentation deck, solicit offers, and watch the hundreds of million of dollars flow into your bank account. Twelve to eighteen months later, you hit the road and do it again — super simple.

While not obvious on the surface, there has been a fundamental sea-change in the investment community that has made the incremental Unicorn investment a substantially more dangerous and complicated practice. All Unicorn participants — founders, company employees, venture investors and their limited partners (LPs) — are seeing their fortunes put at risk from the very nature of the Unicorn phenomenon itself. The pressures of lofty paper valuations, massive burn rates (and the subsequent need for more cash), and unprecedented low levels of IPOs and M&A, have created a complex and unique circumstance which many Unicorn CEOs and investors are ill-prepared to navigate.

Many have noted that the aggregate shareholder value created by all of the Unicorns will vastly overshadow the losses from the inevitable failed unicorns. This likely truism is driven by the clear success of this generation’s transformational companies (AirBNB, Slack, Snapchat, Uber, etc). While this could provide some sense of comfort, most are not exposed to a Unicorn basket, and there is no index you can buy. Rather, most participants in the ecosystem have exposure to and responsibility for specific company performance, which is exactly why the changing landscape is important to understand.

Perhaps the seminal bubble-popping event was John Carreyrou’s October 16th investigative analysis of Theranos in the Wall Street Journal. John was the first to uncover that just because a company can raise money from a handful of investors at a very high price, it does not guarantee (i) everything is going well at the company, or (ii) those shares are permanently worth the last round valuation. Ironically, Carreyou is not a Silicon Valley-focused reporter, and the success of the piece served as a wake-up call for other journalists who may have been struck by Unicorn fever. Next came Rolfe Winkler’s deep dive “Highly Valued Startup Zenefits Runs Into Turbulence.” We should expect more of these in the future.

In late 2015, many public technology companies saw a significant retrenchment in their share prices primarily as a result of a reduction in valuation multiples. A high performing, high-growth SAAS company that may have been worth 10 or more times revenue was suddenly worth 4-7 times revenue. The same thing happened to many Internet stocks. These broad based multiple contractions have an immediate impact on what investors are willing to pay for the more mature private companies.

Late 2015 also brought the arrival of “mutual fund markdowns.” Many Unicorns had taken private fundraising dollars from mutual funds. These mutual funds “mark-to-market” every day, and fund managers are compensated periodically on this performance. As a result, most firms have independent internal groups that periodically analyze valuations. With the public markets down, these groups began writing down Unicorn valuations. Once more, the fantasy began to come apart. The last round is not the permanent price, and being private does not mean you get a free pass on scrutiny.

At the same time, we also started to see an increase in startup failure. In addition to high profile companies like, Quirky, Homejoy, and Secret, numerous other VC-backed companies began to shut their doors. There were in fact so many that CB Insights started a list. Layoffs have also become more prevalent. Mixpanel, Jawbone, Twitter, HotelTonight and many others made the tough decision to reduce headcount in an attempt to lower expenses (and presumably burn rate). Many modern entrepreneurs have limited exposure to the notion of failure or layoffs because it has been so long since these things were common in the industry.

By the first quarter of 2016, the late-stage financing market had changed materially. Investors were becoming nervous and were no longer willing to underwrite new Unicorn-level financings at the drop of a hat. Moreover, once high-flying startups began to struggle on the fundraising trail. In Silicon Valley boardrooms, where “growth at all costs” had been the mantra for many years, people began to imagine a world where the cost of capital could rise dramatically, and profits could come back in vogue. Anxiety slowly crept into everyone’s world....MUCH MORE

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