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2016-01-21 09:32:36
From the January February 2016 Issue
Seven years ago Uber didn t exist. Five years ago it was limited to San
Francisco. Today it offers rides in more than 65 countries and at this writing
is valued at more than $50 billion. Along the way the company has amassed an
impressive war chest to fund its expansion and ward off competitors: It has
raised more than $8 billion from private investors.
The meteoric rise of Uber and other unicorns private, venture-backed
companies valued at a billion dollars or more feels unprecedented. But is it?
And does that matter?
Research from Play Bigger, a Silicon Valley consultancy that works with
VC-backed start-ups, confirms that they really are growing faster in recent
years, at least as measured by market capitalization. It also examines whether
raising lots of private capital prior to an IPO is an important determinant of
future success and looks at the best time for these companies to go public.
The researchers began by exploring speed. They took the market capitalizations
of 1,125 firms started in 2000 or later and divided each by the number of years
since founding; the result is the time to market cap. A company founded five
years ago that s worth $2 billion, for example, has a greater time to market
cap than a company founded 10 years ago that s worth $3 billion. For firms that
have gone public, market cap is the total value of outstanding shares; for
private firms, it s the valuation assigned by VCs during the most recent round
of funding. (Private valuations are less precise, but they re arguably the best
approximation of value creation.)
The results were even more dramatic than the researchers expected. Firms
founded from 2012 to 2015 had a time to market cap more than twice that of
firms founded from 2000 to 2003. In other words, today s start-ups are growing
about twice as fast as those founded a decade ago.
Because the data doesn t go back to the dot-com era, it s not clear whether
today s start-ups are getting big more quickly than those of the 1990s. Some of
the VCs with whom Play Bigger shared its research suggested that the data
merely reflects a bubble. They believe that investors are overpaying for equity
in unicorns, thereby inflating their market caps. In November the Financial
Times reported that Fidelity Investments had written down its stake in Snapchat
reportedly valued at $15 billion at its last fund-raising, in May by 25%. Also
that month, the mobile payments company Square filed for its IPO at a price
range that put the firm s worth significantly below its private valuation,
which was $6 billion in 2014.
Play Bigger founding partner Al Ramadan believes that although a bubble may be
part of the explanation for today s fast growth, fundamental forces are also at
work. Products and services get discovered and adopted at a speed never seen
before, he says. Word of mouth today through Facebook, Twitter, Tumblr,
Pinterest, and so on is just so fast, and it s the most effective means of
marketing. Moreover, the launch of the iPhone, in 2007, not only opened up
opportunities for products and services but also created a new way to rapidly
distribute software, through the Apple and later the Android app stores.
Get big fast has been a start-up mantra since the 1990s. Many VCs try to grow
their companies quickly in order to raise as much capital as possible; having a
cash hoard, the thinking goes, gives a start-up greater flexibility and more
power to fend off potential rivals. But another piece of Play Bigger s research
sounds a cautionary note in this regard.
---
The More Money You Raise, the Less Value You Create
JanFeb16-IW-square
Courtesy of Ryan Garber
Jim Goetz is a partner at Sequoia Capital, one of Silicon Valley s oldest
venture capital firms. He recently spoke with HBR about why start-ups are
growing so quickly. Edited excerpts follow.
WhatsApp, which you funded, was sold to Facebook for $19 billion just five
years after its founding. Is that growth indicative of changes in the market?
WhatsApp spent almost nothing on marketing word of mouth drove adoption. And
today start-ups have the App Store and Google Play, which allow them to touch 3
billion consumers. For the first time in the mobile ecosystem, you can reach
half the planet without building a distribution system. The size and scale of
some new opportunities will reflect that.
If start-ups don t need VC cash for marketing, should they be raising so much
capital?
In our portfolio there is a correlation between cash required and long-term
market cap but it s negative. The more you raise, the less value you create.
Google, Cisco, and Oracle were incredibly efficient with their cash, as were
ServiceNow and Palo Alto Networks. Those companies all had market caps north of
$10 billion within a couple of years of going public. One curse of raising lots
of cash is you lose that discipline. We discourage our teams from raising too
much capital.
What about Uber?
Uber may be the counterexample. Expanding globally became an expensive
proposition, so its war chest makes sense. Airbnb, in which we were an early
investor, has also raised more capital than its cash flow statements and P&Ls
suggest is needed, but for a different reason. Raising capital is attractive
right now, and the company views it as insurance, not as something needed for
operations.
Are we in a bubble?
We don t think so; we think private company valuations of some so-called
unicorns have been inflated by the way late-stage investments were structured.
In many cases investors are protected from much of the downside by terms that
make the deal look more like debt than equity. If investors were unable to get
those terms, they probably wouldn t value some of the unicorns as highly. A
handful or more of these companies may end up with Facebook-like valuations 10
years from now. But several dozen more will disappear.
---
Specifically, the researchers looked at the 69 U.S. companies in their sample
that have raised venture capital since 2000 and subsequently gone public. They
wanted to know whether the amount raised prior to IPO predicted growth in
market cap after IPO a proxy for long-term value creation. They found no
relationship. Candidly, we did not expect this result, says Play Bigger
founding partner Christopher Lochhead. There s a lot of belief in Silicon
Valley that the amount raised really matters.
If money raised doesn t predict long-term value creation, what does? The
research points to two interesting correlations. The first is the age of the
company at IPO. Companies that go public between the ages of six and 10 years
generate 95% of all value created post-IPO, Ramadan says.
It s difficult to interpret the finding that company age at IPO predicts value
creation, because companies today are not just getting big faster but also
staying private longer. And it s not clear whether the link between firm age
and growth in market cap is causal. Are the strongest companies coincidentally
all going public at about the same time? Or is there something intrinsic about
companies that go public very early or very late that inhibits their ability to
create value post-IPO? Play Bigger plans to explore the relationship in future
research.
One possible interpretation of the IPO window is that many unicorns are
missing their chance staying private too long. Start-ups have been in no rush
to go public, preferring to take advantage of plentiful private capital from
hedge funds, mutual funds, and corporate VC firms. Public investors want to see
some upside, so if unicorns remain private through too much of their growth
phase, they may never conduct a successful IPO. And in some cases investors may
wish they d pushed companies to go public sooner, so as to realize returns
while the firms were still growing rapidly. The privately held company Jawbone,
for instance, founded in 1999 and once seen as a leader in wearable devices,
has seen its market share decline and no longer ranks among the top five
vendors in the category, according to the market research firm IDC. In November
it announced that it was laying off 15% of its staff.
The researchers last finding is more qualitative. The group scored the
companies in its sample on the basis of whether they were trying to create
entirely new categories of products or services in order to fill needs that
consumers hadn t realized they had. They looked at whether firms are
articulating new problems that can t be solved by existing solutions and
whether they are cultivating large and active developer ecosystems, among other
criteria. They found that the vast majority of post-IPO value creation comes
from companies they call category kings, which are carving out entirely new
niches; think of Facebook, LinkedIn, and Tableau. Those niches are largely
winner take all the category kings capture 76% of the market.
We hear all the time, Oh, this is going to be a huge market, room for lots of
players, says Lochhead. But that s actually not true.
Tech start-ups are in a race to define new product categories, and the pace has
quickened. Simply raising more money isn t enough to win that race and going
public too soon or too late may limit long-term success. Even for unicorns, the
path forward can be a challenge.
About the Research: Time to Market Cap: The New Metric That Matters, by Al
Ramadan, Christopher Lochhead, Dave Peterson, and Kevin Maney
A version of this article appeared in the January February 2016 issue (pp.28
30) of Harvard Business Review.