Startup Investing in a Hyperactive Market

Recent Funding Rounds in the Tech Sector

As the previous week concluded, news regarding funding for three prominent U.S. technology startups gained traction on Twitter.

Carta successfully secured $500 million in a Series G funding round, resulting in a company valuation of $7.4 billion. Chime completed a $750 million round, achieving a $25 billion valuation. Reports also indicated that Discord was actively seeking additional capital, potentially valuing the company at approximately $15 billion.

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Each of these funding events possesses unique characteristics worthy of examination. This is because, while the unicorn market is increasingly competitive – attaining a $1 billion valuation is no longer uncommon in the current investment climate – the number of startups exceeding that valuation multiple is expanding rapidly.

Understanding the rationale behind investors’ willingness to acquire small ownership stakes in numerous private companies valued in the billions is crucial to comprehending the surge in investment observed among emerging technology companies.

Unicorn Market Growth

CB Insights’ unicorn leaderboard currently lists 55 companies with valuations of $7.5 billion or higher. This represents almost five dozen companies now valued above Carta following its latest funding round.

Furthermore, the list identifies 38 of these unicorns as being worth $10 billion or more.

Collectively, the 55 startups valued at $7.5 billion and above represent a total value exceeding $1 trillion. The 38 "decacorns" – companies valued at $10 billion or more – are collectively worth over $900 billion.

We have grown accustomed to simply acknowledging large funding rounds and their corresponding valuations. Therefore, today we will analyze Carta, Chime, and Discord, and explore the factors that may have contributed to their recent, or anticipated, valuation increases.

The term "unicorn" generally refers to a growth-focused group of technology startups. However, as a startup approaches a $10 billion valuation, it begins to outgrow its current market position.

These companies represent the next wave of potential IPOs, both within the United States and internationally.

Analyzing the Companies

We will proceed in alphabetical order, primarily to avoid discussing Chime first. Acknowledging Hunter Walk’s early investment success in the company should be minimized.

Therefore, we will begin with Carta.

Carta Sets Its Own Valuation, Challenges Investor Norms

The recent capital raise by Carta at an increased valuation isn't particularly noteworthy on its own. While the company, specializing in cap table management and valuation software, is performing well, securing funding is a core competency for Carta. They successfully raised capital in 2017, 2018, 2019, and 2020.

However, the manner in which Carta determined its price is particularly compelling. A $100 million transaction involving Carta shares on its internal secondary market resulted in a company valuation of $6.9 billion. This figure was subsequently adopted as the pre-money valuation for their latest $500 million funding round.

This approach can be described as remarkably assertive. It’s important to remember that prior secondary sales of stock in companies such as Uber, Robinhood, and Coinbase, preceding their initial public offerings, often resulted in inflated valuations. Secondary market transactions aren’t always reliable indicators of a unicorn’s true value, especially as it nears a liquidity event.

Despite this, Carta proceeded with raising capital based on its market-determined price.

Moving forward, Carta has effectively pioneered a novel method for valuing private equity in anticipation of future investments. What prevents other unicorn companies from adopting a similar strategy, presenting investors with a valuation of x billions of dollars based on activity within a secondary exchange? The question remains whether investors will broadly embrace this pricing model.

Carta’s funding round may ultimately be an isolated instance, akin to Google’s unconventional reverse Dutch auction IPO. Alternatively, it could signal a significant shift in the market. Regardless, it underscores the willingness of capital providers to invest in technology companies perceived as having long-term sustainability. It appears these investors are even prepared to delegate the process of price discovery, as evidenced by this case.

Chime’s Unusual Need for Capital

It’s hardly surprising that Chime, like Carta, has secured additional funding. The fintech company has consistently raised capital annually since 2016. While the recent funding round establishes a company valuation of approximately $25 billion – an increase of around $10 billion from its 2020 private valuation – such substantial growth isn’t entirely unexpected.

What is more perplexing is the rationale behind Chime’s decision to seek further investment. An initial public offering (IPO) is anticipated in 2022, which would inherently provide access to significant capital within the year.

Although it’s typical for companies preparing for an IPO to secure a final round of funding beforehand, Chime’s situation presents unique circumstances that render its fundraising somewhat atypical.

A year ago, Chime’s $485 million funding round resulted in a $14.5 billion valuation. At that time, the company demonstrated profitability, generally without accounting complexities.

While GAAP net income is always preferred, achieving positive earnings before interest, taxes, depreciation, and amortization (EBITDA) is a notable achievement for a rapidly expanding company like Chime.

Given its near-profitability during last year’s $500 million raise, the need for additional cash before an IPO is questionable. Perhaps Chime intends to pursue acquisitions prior to going public, for which cash reserves would be beneficial.

Alternatively, the company may be planning a significant product launch, or its spending may have increased following the 2020 funding round. Is Chime considering a direct listing next year, effectively treating this as its IPO round?

The substantial amount of capital raised by Chime warrants further investigation. Access to the company’s financial statements would greatly aid in clarifying the situation.

Discord’s Ascending Valuation

In contrast to Chime, the communication platform Discord currently operates without consistent profitability. However, this circumstance isn't hindering its potential to secure a valuation exceeding $15 billion in its forthcoming funding round.

Reports from The Wall Street Journal indicated that Discord generated approximately $130 million in revenue during the previous year, a significant increase from the $49 million recorded in 2019. Assuming the company maintains its current growth trajectory, projecting an annual run rate of $200 million or higher is reasonable. Consequently, a $15 billion valuation would represent approximately 75 times its present run rate.

Is this valuation substantial? Certainly. Is it unrealistic? Not in the current market conditions.

This situation highlights trends within the broader startup ecosystem. These funding rounds serve as an incentive for early-stage investors to continue providing capital. This is because they demonstrate that investors at later stages and those crossing over are prepared to offer substantial increases over previous investment prices.

Furthermore, it suggests considerable potential for startups to secure funding at valuations exceeding $5 billion. This valuation level would allow earlier investors to access liquidity before an initial public offering (IPO).

Consequently, early-stage investors face reduced risk, provided the current abundance of late-stage capital continues to flow towards startups widely anticipated to become prominent publicly traded technology companies. The convergence of these factors last week simply affirmed the continued vibrancy of the private tech market.

While the growth of valuation multiples for publicly traded tech companies may be leveling off, the private technology market continues to push pricing boundaries and encourage increasingly bold investment strategies.