For some time now, the investment market for startups has been taking on more risk, slipping more frequently into public markets. This means that the regular investor can now get their hands on more initial capital than before thanks to, for example, SPACs and other attractive public offerings (IPOs).
Una Special Purpose Acquisition Company (SPAC) is a company that does not have commercial operations and is formed strictly to raise capital through an Initial Public Offering (IPO) in order to acquire or merge with an existing company. Also known as "blank check companies," SPACs have been around for decades, but their popularity has skyrocketed in recent years. In 2020, 247 SPACs were created with $80 billion raised, and in the first quarter of 2021 alone, a record $96 billion was raised across 295 newly created SPACs. By comparison, only two SPACs hit the market in 2010.
But within that point was the implicit argument that the risk in startups it is also increasing by its private sponsors in the market. Let's talk about what's going on:
- The start-up valuations are rising thanks to the ample availability of capital, limited investments with a strong return and related aspects. This is not a new scenario. It has happened before.
- The initial valuations are also increasing thanks to the fact that more investments are made in the very incipient process of the startup. Although this has also happened before, there is no perception that this is a self-reinforcing problem. Large funds invest at an “earlier” stage than they used to, given the size of their funds, essentially writing an option contract on a larger purchase of shares in the startup in question without risking its overall return profile. This favors that the capital that appeared in later stages, in general, is encouraged to invest earlier. And so valuations rise as later-stage investors are less price sensitive than early-stage valuations thanks to a differential in money price perception. As an example, 1 billion to invest and 5 million are placed in a Serie AIt doesn't matter much if you have a pre-money valuation of 65 million or 75 million. What really matters to the investor what matters is putting 50 million more among the winners when they raise their next round of investment.
- Reinforcing this positioning, investors report that emerging company valuations are rising in part because growth rates are not only stronger than those of previous technology companies, but also because their growth rates are proving to be larger and more durable than expected. That is, old start-ups are going public with faster growth than many expected, and holding on to that pace of expansion for longer. The impact of that is that tech companies may be worth more in the future than anticipated, so investors may pay more now and not worry as much incrementally as one might expect.
- Another factor to consider with respect to the price increase that the investor of Menlo Matt Murphy has recently explained is that companies' old expectations about startup failure rates are now wrong. The closing rate is lower than it was, and more importantly the success rate is higher.
Pondering these points, one would think that growing unicorns and 6-figure investment rounds make sense.. After all, the supposedly smart money is betting on faster, longer lasting growth with fewer company closures, essentially in a SaaS environment that is hard to fall for. fracaso, will offset the higher costs to generate the kind of returns needed to make the math of risk add up.
But on the other hand, more and more risk is being taken on despite the fact that the foundations of the startup market have not improved much. After a COVID-induced boom in software purchases, after a short period that increase disappeared. I mean, the startups that venture capitalists are backing this year haven't really seen their macro fortunes improve since mid-2020, but they're busy raising a lot more money, a lot faster. That creates a higher investment risk.
There are over 900 unicorns on the market today, all of which will need IPOs to generate the kind of return their backers expect. If the market eventually corrects a bit, to be somewhat more in line with historical and listed companies, a good number of high priced companies could find themselves stuck in limbo between their private market valuation and what the public markets could pay. That could produce a contagion effect, although people are betting that it will not happen.
While there are thoughtful reasons why startup prices are rising, as more capital is also being raised, sooner and faster, it's not a zero marginal risk bet.
