In a nutshell, the problem is that, at the moment, private markets are valuing companies at what appears to be higher valuations than possible to achieve in public markets. For example, if private investors are valuing Uber at $50 billion, this implies the expectation that when Uber does engage in an initial public offering, its value will be greater than what it was given by private markets.
The issue is that it is not likely to happen.
That is, Uber certainly has a ton of value, but the public markets may not be willing, at least at IPO time, to invest more than private markets. Bill Gurley, an investor at Benchmark, last week pointed out that this is going to be the case, because in public markets, tech stocks are shedding market caps.
This means that the gap between the private valuations for the unicorns, or companies valued at or above $1 billion, and what the public market will pay is now even wider.
When or if Uber and other IPO candidates decide to pull the trigger, the prices may not be high enough. This would imply either a slowdown of IPOs or actual IPOs where public-market prices are lower or even several last rounds of private valuation. That is, the last few rounds of private money into unicorns may end up losing money on IPOs.
In general this is OK, and is just a consequence of startups and early-stage investments being risky. There is no such thing as a guaranteed return for investors in any round, much like there is no guarantee that a founder who grinded for 10 years will make a penny.
Unlike the first dotcom bubble, this coming downturn may impact private capital but not likely public capital. In the dotcom bubble, the general public rushed to buy tech stocks only to then see them crash and burn. The public lost money. This is not likely going to happen today.
So macro economically and more important, psychologically, your next-door neighbors aren't going to pull their hair out. Instead, this coming downturn will directly impact later-stage venture firms and private wealthy individuals who bought into the unicorn stocks at high prices.
But this not the whole story. The money comes in chunks and is all part of an intricate interdependent macro economy. Without a doubt, if the most valuable companies in tech will be hurt, that pain will trigger more hurt through the entire tech ecosystem.
In short, there will be less capital available to startups of all sorts and it will be available at significantly lower valuations. Venture capitalists will have harder time raising capital as well. There will be less capital available in the system overall, and it will be more costly to obtain it.
But there are a bunch of tangible things that your company can do to be more prepared:
1. Don't panic.
It is sort of obvious advice, but things such as this have happened before. Up and down cycles are a normal part of any economic system. Whatever is coming will not likely be worse than the dotcom bust because public money has not been invested at absurd multiples.
2. Drink while served.
I've heard Mark Solon, partner at Techstars say this to many founders, and it is a great lesson. Raise capital when you can. Raise a little more capital if offered. We consistently see how difficult it is to get from series seed to series A. Having a little more capital at your disposal, even at the expense of some incremental dilution, might be prudent, especially in the upcoming cycle.
3. Spend less.
Get stingy and frugal, it is a wonderful thing. Review what you are spending money on, and cut the expenses that aren't necessary. Frugality was and still is one of the core values at Amazon. You make money by not spending money on things you don't need is one of the great secrets of a lot of wealthy people. I encourage you to read this great post by Joe Fasone, CEO of Pilot: There is always a deal.
4. Think revenues.
Sometimes in early-stage startups, revenue and growth are at odds. Asking customers to pay creates ultimate friction, and slows down growth. But revenue is a wonderful and liberating thing. Not having revenue and not knowing how you will make money is scary. Especially in the downturn cycle companies that have no clear way to make money are in danger. It does not mean you have to be profitable and self-sustaining (although this is also a wonderful thing), but having revenue and understanding how to grow and scale becomes more important.
5. Discuss and get help.
What remains constant is patterns across startups. Your investors, advisors and peers have seen this or something like this before. Engage in conversations of what this upcoming cycle means to your company. Get feedback and advice. Get more data. Use people around you to make decisions that make sense for your company.
I would love to hear your thoughts. What do you think about this situation? What is your plan? Leave your comments in the section below.