The Sudden Deluge of Unicorn IPOs
The term unicorn refers to a start-up company which has a valuation of $1 billion or more. When the term unicorn was created, the companies themselves were as rare as unicorns. There were only about 39 companies in the entire world which fulfilled the criteria and could, therefore, be called a unicorn.
However, this has changed after the deluge of easy money that the world has witnessed. Quantitative easing, lower interest rates, and other such easy money policies unleashed a tidal wave of capital in the market.
The interest rates were so low that the returns provided by safe investments such as treasury bonds were abysmal. As a result, high net worth individuals were ready to pump in money into businesses which seemed promising. The business model of burning cash upfront in order to earn huge profits later was popularized by companies such as Facebook.
In this article, we will try to understand why so many unicorns are suddenly going public at the same time!
The Breakneck Speed of IPOs
During the period from 2009 to 2019, the number of Unicorns in the market has simply exploded. However, that is not where the similarities end.
Companies such as Lyft, Uber, Airbnb, WeWork, etc. opened up a new economic frontier. All these companies were riding on the back of a smartphone boom. Also, most of these apps had taken daily tasks such as ordering a taxi or booking a hotel and converted it into an on-demand service.
Now, suddenly all these companies are lining up for IPOs at the same time as well. Uber and Lyft have already unveiled their IPOs. Other companies such as Airbnb and WeWork have announced their plans to go public within 2019. It is strange that all these companies are going public at the same time. Together, they will end up increasing the competition in the market. This is because additional securities worth hundreds of billions of dollars will be floating in the market, whereas the amount of money is likely to reduce since a recession may just be around the corner.
Lets understand how this sudden deluge of unicorn IPOs will impact the start-ups.
Cash Will Dry Up: A few years earlier, start-up companies used to go public a lot earlier than modern day companies. This was largely because of the fact that they did not have access to huge piles of investor cash which they have today.
All unicorns have been burning through cash for many years now. This would not have been possible a few years earlier. Also, if a recession sets in, it may not be possible later. If the Fed changes its policies, the total amount of money available in the market will reduce. As such, there will be less cash available to unicorns.
It is likely that the management of these unicorns have already sensed that we are overdue a recession. Therefore, they are trying to make a beeline for exit via the IPO route before the downturn sets it.
If the cash actually dries up, many of these unicorns will simply not be able to survive. On average, these companies have about 18 months of cash on hand. Therefore, to avoid the entire situation, an IPO seems like a safer and more viable option.
Valuations Will Be Lower: Start-up companies grow based on hype. A lot of these companies are still bleeding red ink i.e., they do not make any profit. Hence, their value depends upon the euphoria of the investors backing them.
This euphoria is expressed when investors value the company. Typically for unicorns, every round of financing that they receive, they sell their shares at a higher price. This creates an illusion that the investment is growing in value and tempts more investors to buy shares in order to get a piece of the action.
On the other hand, if unicorns were to sell their stake during a downturn, they would receive a down round i.e., their shares would be valued lower as compared to the previous stake sale. This creates negative sentiments about the firm. As a result, more investors want to shun the investment creating a vicious downward cycle. It is evident that companies like Uber, Lyft, etc. want to avoid successive down rounds. This is the reason why they are selling just before the recession kicks in so that they are able to cash in on the highest possible valuation.
Employee Options: A lot of employees at these start-up companies have stock option plans. This is truer of higher management and critical employees. These employees can only realize their gains if the actual stock price reaches an agreed upon strike price.
In case of a recession, the prices would fall further. Hence, the chances of employees unlocking their fortunes will be greatly reduced in the event of a downturn. In order to avoid this predicament, employees at these unicorn start-ups are insisting on an IPO so that their personal net-worth also increases along with the companys valuation.
The bottom line is that it is very unusual that all the unicorns are launching their IPOs at the same time. This could be seen as a leading indicator of an upcoming recession.
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