Why Startups Should Postpone Going Public Until Interest Rates Stabilize
Introduction
Venture capitalists are advising startups to postpone their plans to go public in the United States until interest rates stabilize. The recent faltering debuts of Arm and Instacart have dampened hopes for a wave of new technological quotations. This article explores why it may be wise for startups to delay their initial public offerings (IPOs) until market conditions are more favorable.
The Impact of Recent IPO Performances
The IPO performances of companies like Instagram, Arm, and Klaviyo have raised concerns among investors. Although these companies had strong starts in the public markets, their performances have been overshadowed by the Federal Reserve’s indication of interest rate hikes and fewer cuts than expected in 2024. As a result, Silicon Valley investors are frustrated, and many startups have delayed their IPO plans after the market turned sour in 2021.
Turbulent trading conditions throughout September created uncertainty for potential IPO candidates. Despite the optimism surrounding the listings, the market has proven difficult in recent weeks. This has prompted venture capitalists to recommend that startups hold off on going public unless absolutely necessary. Mike Volpi, a general partner at venture capital firm Index Ventures, suggests waiting until the second half of next year unless there is an urgent need to go public.
The Risks of Going Public in Unstable Market Conditions
Unstable interest rates can pose significant challenges for unprofitable private startups. These companies are valued based on their future cash flow, which is affected by interest rate fluctuations. Until interest rates stabilize, there is unlikely to be a resurgence in IPOs. Moreover, startups that are forced to go public due to factors beyond raising capital for growth or providing liquidity may face additional risks.
According to Jason Greenberg, co-responsible for global technology, media, and telecommunications investment banking business at Jefferies, startups most likely to go public next are those forced to do so by factors beyond traditional goals. This suggests that companies driven by external pressures rather than a strategic plan may not be as well-prepared for a successful IPO.
The Importance of Liquidity and Investor Expectations
Venture capital firms, unlike private equity or public investors, operate on a longer-term basis. These firms generally have funds with a 10-year life cycle and need startups to go public or find other exit routes to distribute returns to their investors. The return on investment serves as a proof point when raising the next fund from backers, including pension funds and institutional investors.
Investors’ need for liquidity may push startups into the public market sooner than desired. This creates a potential risk for companies that are not as valuable as initially thought but are pressured to make a deal. Startups facing financial challenges or needing capital for growth may find themselves in this position.
Unique Perspectives on the IPO Market
While recent IPO performances may have raised concerns, some experts believe that the IPO market is still open for mature companies with attractive growth prospects. Despite being more demanding, public investors are willing to invest in companies that demonstrate promising growth. For example, Klaviyo, a marketing technology company that serves corporate clients, experienced rapid growth during the pandemic and trades near its peak private valuation of $9.5 billion.
Moreover, companies in the “software as a service” (SaaS) sector, like Klaviyo, offer more predictable revenues to public market investors compared to consumer-facing companies like Instacart. This predictability is due to the subscription-based model that SaaS companies typically employ. Therefore, opportunities for IPOs remain for companies with strong growth potential and solid business models.
The Role of Interest Rates in IPO Prospects
To fully assess the outlook for IPO candidates, it is crucial to consider the stabilization of interest rates and the overall economic outlook. Until interest rates have finally stabilized and market conditions become more predictable, the IPO market will likely continue to face uncertainties. While the IPO window may be open to some extent, the full potential of the market may not be realized until interest rates stabilize.
Conclusion
In conclusion, the recent IPO performances of companies like Instagram, Arm, and Klaviyo have raised concerns among venture capitalists. Startups are advised to postpone their plans to go public until interest rates stabilize, as unstable interest rates can pose significant risks to unprofitable startups. However, there are still opportunities for IPOs for mature companies with attractive growth prospects, particularly in the software-as-a-service sector. It is crucial to consider the stabilization of interest rates and the overall economic outlook when assessing the prospects of IPO candidates. Until market conditions improve, startups should carefully evaluate the risks and benefits of going public.
Summary
Venture capitalists are advising startups to postpone their plans to go public in the United States until interest rates stabilize. The recent faltering debuts of Arm and Instacart have dampened hopes for a wave of new technological quotations. Unstable interest rates can pose significant challenges for unprofitable private startups, and until rates stabilize, there is unlikely to be a resurgence in IPOs. Startups that are forced to go public due to factors beyond traditional goals may face additional risks. It is crucial to consider the stabilization of interest rates and the overall economic outlook when assessing the prospects of IPO candidates. Despite the challenges, opportunities for IPOs remain for mature companies with strong growth prospects, particularly in the software-as-a-service sector.
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Venture capitalists are advising startups to postpone plans to go public in the United States until interest rates stabilize, after the faltering debuts of Arm and Instacart dampened hopes for a wave of new technological quotations.
Online grocery delivery company Instagramwhose initial public offering on September 19 was considered pivotal barometer for other private technology companies, it ended the month below its $30 listing price, despite rising as much as 40% in early trading.
Armthe SoftBank-backed chip designer has fluctuated above and below its $51 list price in the two weeks since its IPO but it closed the month with an increase of almost 5%. Marketing automation software company Klaviyo is the best performing company of the three, up 15% from its IPO price.
All three companies had strong starts in the public markets, but these were overshadowed by the Federal Reserve indicating on September 20 – the day of Klaviyo’s debut – that would argue another interest rate hike this year and fewer cuts than expected in 2024.
Turbulent trading conditions throughout September frustrated Silicon Valley investors who hoped the month’s listings would open the door to dozens more private technology companies going public. Many start-ups had delayed theirs IPO plans after the market turns sour in 2021.
“In our portfolio we recommend: unless you really have to, hold off,” said Mike Volpi, general partner at venture capital firm Index Ventures. “The market has been difficult in recent weeks. . . Unless you need to get out, I would wait until the second half of next year.
As public listings remain risky, the startups most likely to IPO next were “those forced to do so by factors beyond the traditional goals of raising capital for growth or providing liquidity,” said Jason Greenberg, co- responsible for global technology, media and telecommunications. investment banking business at Jefferies.
Private markets data firm PitchBook estimates a backlog of nearly 80 IPO candidates has built up over the past year, a period when public markets have soured on tech startups. But some investors have tried to take a long-term view.
“Everyone thought IPOs were dead, but they’re not,” said Paul Kwan, managing director at venture capital firm General Catalyst and former head of West Coast technology banking at Morgan Stanley. The trio of September listings “didn’t represent a big turning point,” he added.
Interest rate increases are particularly painful for unprofitable private start-ups, which are valued based on their future cash flow. Until rates stabilize, Kwan said, there is unlikely to be a resurgence in IPOs. He expects an increase in mergers and acquisitions among private companies in the next six months.
Some companies may be forced to go public sooner or later because they need new capital to survive or grow – “not a good IPO story,” Greenberg warned – or to pay taxes associated with vesting employee stock shares.
In recent years, many private Silicon Valley companies – including Instacart, Klaviyo and payments group Stripe – have offered stafflimited stock unit” which allow them to cash out when a company is acquired or goes public.
In March, Stripe relaunched more than 6.5 billion dollars in a private stock sale, in part to cover employee tax liabilities associated with the vesting of such RSUs. According to a person familiar with the matter and the company’s S1, Instacart would use “effectively all” of the approximately $600 million in proceeds from its IPO to settle costs associated with vesting RSUs.
Klaviyo is using nearly $60 million of its IPO proceeds to settle outstanding RSUs.
A third factor pushing startups into the public market is their investors’ need for liquidity, according to Don Butler, managing director of venture fund Thomvest.
Venture capital firms invest on a longer-term basis than private equity or public investors, with funds generally operating on a 10-year life cycle. The return on investment of such funds is a proof point when raising the next fund from backers, who typically include pension funds, endowments and other institutional investors.
But venture capital firms need startups to IPO or find another exit route, such as a sale, to distribute returns to their investors. Some would accept that their companies were not as valuable as once thought if it meant making a deal, Butler said.
Instacart, Klaviyo and Arm are proof that “the IPO window is open, if cracked by historical standards,” said Peter Hébert, co-founder of venture capital firm Lux Capital.
“While public investors are much more demanding than in recent years, mature companies with attractive growth prospects can raise public funds if they wish,” Hébert said.
Klaviyo provides a more promising signal to other potential IPO candidates that serve corporate clients, rather than consumers. The marketing technology company continued to grow rapidly during the pandemic while others were cutting back and trades near its peak private valuation of $9.5 billion, set in 2021.
So-called “software as a service” companies like Klaviyo tend to offer public market investors more predictable revenues, as customers pay a monthly subscription, than consumer-facing companies like Instacart.
However, according to Greenberg, the outlook for even the strongest IPO candidates is unlikely to be clear until interest rates have finally stabilized and the economic outlook is more stable.
“The window is open? 100%,” she said. “Do I think ads will take off? No. Not for another six months.
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