Future Tech Exits: High Expectations and Challenges

Startup Valuations: A Notable Increase

Whether the current rise in consumer prices will be temporary remains to be seen. However, a clear trend is emerging: startup valuations are demonstrably increasing in recent financial periods.

PitchBook's Valuation Analysis

This observation stems from a recent report by PitchBook, which analyzed valuation data from numerous U.S. startup funding rounds. Although the data focuses on the American startup ecosystem, the observed patterns are likely mirrored internationally.

The same surge in venture capital that has fueled record investment in U.S. startups is also being experienced in regions such as India, Latin America, Europe, and Africa.

Implications for Future IPOs

The accelerating growth in startup valuations presents a challenge. Future initial public offerings (IPOs) will need to not only maintain existing equity valuations but potentially surpass their previous private-market assessments.

Evolving antitrust regulations could restrict substantial future mergers and acquisitions. This may leave numerous startups with elevated valuations and limited options for realizing returns on investment.

The Unicorn Bottleneck

This scenario echoes a previously discussed issue: the “unicorn traffic jam.” Global startup markets are consistently generating a greater number of companies valued at $1 billion or more than the public markets have traditionally been able to absorb.

Key Statistics

Let's examine some significant figures that illustrate this trend.

• Valuation Growth: Startup valuations have experienced a substantial increase in recent quarters.
• Global Impact: The venture capital boom is not limited to the U.S., extending to key emerging markets.
• IPO Pressure: Startups face increasing pressure to deliver returns exceeding private market valuations upon going public.

Antitrust Concerns: Potential regulatory changes could impact the size and frequency of future acquisition deals.

Unicorn Saturation: The number of billion-dollar startups continues to outpace the public market’s capacity for absorption.

Startup Valuations: An Upward Trajectory

According to recent data from PitchBook, investment round sizes are increasing in tandem with rising valuations. However, valuations are outpacing the growth in round sizes, meaning investors aren't securing a greater share of ownership despite increased deal access costs.

Early-Stage Deal Size Increases

Deal sizes within the early-stage market are demonstrably growing, as illustrated in the following data.

Price Appreciation

Alongside increasing deal sizes, prices are also experiencing an upward trend, as depicted in the chart below.

Declining Equity Take Rates

This price escalation is contributing to a corresponding decrease in the equity stake investors are able to acquire.

Rapid Changes in Venture Capital

These trends highlight the speed at which the venture capital landscape is evolving. In 2020, the median early-stage value created between funding rounds was $16 million, representing a 54% relative velocity.

However, in 2021 to date, this figure has surged to $39.4 million, equating to a 120% relative velocity. The 2020 value was a record at the time, but it has since been surpassed.

Record Valuations

The PitchBook data reveals further noteworthy milestones. Average pre-money valuations for enterprise-focused seed rounds reached $11 million in the first half of 2021, establishing a new all-time high.

Early-stage valuations for enterprise startups also achieved record levels, averaging $92.7 million and with a median of $43 million, following consistent growth since 2011.

Vertical Growth in Late-Stage Valuations

Late-stage valuations for enterprise tech startups have experienced substantial growth, as shown in the following chart.

Momentum in the U.S. Late-Stage Venture Capital Market

The entire U.S. late-stage venture capital market is currently experiencing significant activity. Despite a period of slower valuation growth between 2016 and 2017, prices for late-stage venture capital rounds have increased considerably in the first half of 2021.

Reasons for Rising Valuations

Before expressing concern, it’s important to acknowledge the underlying factors driving these valuation increases.

The software market has proven to be larger than initially estimated. Consequently, tech companies are capable of achieving faster growth over extended periods, which was not fully reflected in earlier valuations.

With a better understanding of the total addressable market for software, and therefore startup TAM, it’s logical that early-stage prices are rising as the present value of future cash flows increases.

Decreased Risk Factors

Beyond market size, the risk associated with startups has also diminished. The increasing focus on software within the startup ecosystem has reduced execution risk.

Lower startup risk translates to higher prices, as a broader range of capital sources can now participate in private markets. Increased capital availability leads to greater competition for deals, further driving up prices.

Summary

The increase in prices for startup equity is generally understandable, given several identifiable macroeconomic trends.

However, this doesn’t necessarily mean that the current price increases are entirely justified; it simply suggests they aren’t entirely unreasonable. It remains valid to argue that certain deals may be overvalued.

Considering Exit Strategies

A key consideration revolves around exits, particularly concerning exit value and the potential for shareholders to realize liquidity from startups currently securing substantial funding.

A broader macroeconomic factor influencing this is the increasing antitrust scrutiny directed towards major technology corporations. This could diminish the willingness of these large entities to acquire startups at elevated valuations.

Regulatory hurdles could make acquisitions less appealing, potentially restricting the prices startups can achieve when acquired by publicly traded tech giants. Consequently, the overall number of transactions might also decrease, a trend already observable among the largest five tech companies.

This situation directs attention to Initial Public Offerings (IPOs), but the historical challenges faced by unicorns remain. Recent IPO market strength hasn’t significantly reduced the backlog of unicorn companies seeking exit opportunities.

The rate at which new unicorns are emerging continues to outpace the rate of successful exits, and current valuation trends suggest this imbalance will likely persist. This creates a growing number of companies awaiting a viable exit path.

What potential solutions exist? Direct listings, perhaps implemented on a large scale, could offer some relief. However, their limited track record and infrequent successful execution make this a challenging prospect.

The popularity of SPACs (Special Purpose Acquisition Companies) is waning. This leaves traditional IPOs as the most probable, and perhaps only, exit strategy for the expanding population of unicorn companies. An accelerated IPO schedule might be necessary to address the growing backlog.

Currently, investors seem to be operating under the assumption that the IPO market will experience a sustained period of acceleration at favorable pricing. Without this expectation, the recent surge in startup valuations appears unsustainable.