It’s been less than a month since “Pre-IPOs: Square Slips Through a Growing Hole” was published, but there is already plenty more evidence that the best days for the privately-held start-up market are behind it. As CNBC noted, “the unicorn club is filling up, and it’s causing unease among investors.” Citing data by PrivCo, a company that provides financial data on the sector, the business channel reported that many tech firms, including the $1 billion-plus unicorns, “are reluctant to go public because of the shaky IPO market.”

A variety of factors are contributing to the malaise. As detailed in “Déjà Vu All Over Again in the IPO Market?” the appetite for new deals has waned following a very strong 2014. Overall, 169 IPOs came to market in 2015, representing 39% and 69% declines, respectively, in volume and funds raised versus year-ago totals. The diminished interest in new offerings occurred against a monetary, economic and equity market backdrop that was largely supportive during the first half of the year.

A bad combination

More recently, the Federal Reserve’s long anticipated change in policy has rattled investors, helping to push share prices–and sentiment–lower in the wake of the move. The combination of historically high valuations, improving yields on cash and various short-term fixed-income investments, a rising dollar, and a bull market that many would say is long in the tooth has spurred apprehension about the outlook for equities.

Not surprisingly, that nervousness has spilled over into the private market arena, undermining the confidence required to launch new offerings. According to venture capitalists and technology investors polled by CNBC, “2016 is shaping up to be a year of reckoning for scores of technology start-ups that have yet to prove out their business models and equally challenging for those that raised money at unjustifiably high prices.”

A narrowing of the gap between public and private market valuations is also unnerving investors. While it could be argued that a decline in the latter should, theoretically at least, make it easier for unicorns and other privately-held companies to raise money in public markets, that fact has been overshadowed by concerns about the haircuts that investors will take on prior funding rounds when the firms come to market.

Even then, it is not entirely clear how large those differences might be. In October, the Wall Street Journal analyzed “closely held technology startups worth at least $1 billion [and] found 12 instances where the same company was valued differently by more than one mutual-fund manager on the same date.” The newspaper noted that prices are difficult to determine and can vary a great deal among firms that rely on internal processes and assumptions that are not publicly disclosed.

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Another report illustrates how much things have changed from more exuberant times. According to a study by Battery Ventures, which examined valuation and return data for U.S.-based tech firms that have come to market since 2011, “about 40% of the IPOs are flat or trading below their last private-market valuations.” Referencing the research, VatorNews noted that while companies in 2003 had seen returns of over 6 times their pre-IPO valuation, those figures had dropped by two-thirds since then.

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The fact that a portfolio manager at Fidelity Investments, one of the biggest players in the pre-IPO market, is becoming cautious is not helping, either. According to Reuters, “Will Danoff, one of the U.S. mutual fund industry’s best stock pickers over the past 25 years, is tapping the brakes on funding so-called unicorn companies, saying the prospects for fast-growing private businesses before they go public may be fading.” That follows unsettling reports in recent months that the Boston-based firm had marked down the value of some of its private-market holdings.

Other reasons for caution

Corporate governance and regulatory worries have likely also played a role in unsettling the pre-IPO market. CFO highlighted research by consulting firm PwC that found “the percentage of IPOs revealing material weaknesses in their internal controls before they go public has been rising steadily.” While the revelations have largely been driven by concerns about the Sarbanes-Oxley Act of 2002, which requires managers of public companies to certify the accuracy of certain financial reports, they have also served to underscore the private market’s more relaxed reporting and disclosure regime.

In late-November, The Wall Street Journal reported that the Securities and Exchange Commission was “intensifying a broad investigation into trading of pre-IPO shares, zeroing in on companies that help technology-firm employees and others resell their” holdings. The decision by many high-profile companies to delay going public has spurred some holders of pre-IPO shares to try to cash out sooner rather than later. The SEC has, in turn, been investigating whether some firms have violated federal securities laws by facilitating trading in “growth-stage” private companies’ shares.

In the end, of course, the question of whether the pre-IPO market will exit the doldrums or deteriorate further depends to a great extent on what happens in the equity market. If this week’s post-Fed swoon proves to be the start of something bigger, it is likely that more than a few tech firms will find themselves gored on unicorn horns.

Michael Panzner

Michael Panzner

Michael J. Panzner is a 30-year Wall Street veteran and the author of three books, including Financial Armageddon, which predicted the 2008 global financial crisis.
Michael Panzner

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