Last Updated: January 26, 2016

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An earlier article at Sophisticated Investor argued that the outlook for growth stage private companies, especially the $1 billion-plus technology “unicorns,” was looking shaky. Developments since then suggest the situation has gotten worse.

For one thing, the equity market appears to be in the throes of a bear market, kicked off in part by the Federal Reserve’s December interest-rate hike. Since the year began, the S&P 500 index has lost 6.7%, one of its worst starts ever. The technology laden NASDAQ Composite index has fared even worse, losing 8.3% over the span.

Among the stocks that have helped to push the major averages lower are last year’s best performers, the FANGs–Facebook, Amazon, Netflix and Alphabet (Google). So far, fundamental reasons for the decline seem lacking, but weakness in other sectors and diminishing risk appetites have encouraged investors to take some winnings off the table.

Losing their mojo

Not surprisingly, the fact that large cap technology shares have suddenly lost their mojo is being viewed as less-than-supportive for private market counterparts. These include companies such as Uber, Airbnb, Palantir and Snapchat, which are valued at $62 billion, $25.5 billion, $20.5 billion and $16 billion, respectively, according to Fortune.

Indications that many firms will be unable to raise fresh capital at better terms than in the past suggest these numbers could prove as fanciful as the “unicorn” moniker. According to the New York Times, “the downturn in the market will force these onetime high-fliers to seek money at valuations below their earlier billion-dollar-plus levels, known as ‘down rounds.’”

Some investors are already factoring this in. Fortune reported in late December that Fidelity Investments had “again taken out its red pen for several well-known startups,” noting that the firm had marked down the value of some holdings, including Dropbox, Blue Bottle and Snapchat, by 2.29%, 4.58%, and 0.1%, respectively, at the end of November.

Citing data from The Information, GeekWire revealed that T. Rowe Price had revalued its stakes in Dropbox, Apptio, Evernote and other private-market firms last quarter. In the case of the well-known cloud-based storage provider, the mutual fund company reportedly slashed its value by 51% from what it was only three months earlier.

No exit

It doesn’t help that one path toward monetizing these investments is apparently blocked. As noted in “Déjà Vu All Over Again in the IPO Market?” the market for public offerings has been losing steam after its heady performance in 2014. In fact, Yahoo! Finance maintains that Elevate Credit’s decision to postpone what would have been the first deal of 2016 means the IPO market “remains closed.”

If and when this changes, that doesn’t necessarily mean the private market’s woes will be over, if the view of one expert is anything to go by:

All signs point to a continued slowdown in tech IPO activity in 2016, says Kathleen Smith, a principal at Renaissance and the company’s manager of IPO-focused ETFs. She says it won’t take long for the unicorns to feel the chill as well. “What’s happening now is just going to take the bottom out of these private valuations, many of which are imaginary,” says Smith. “And this valuation reset is going to have a very negative effect on new funding.”

Public Display of Disaffection

The fact that the performance of private companies that did come to market last year was less than stellar is not helping, either. Business Insider notes that while unicorn IPOs were, on average, up 10%, only three of the seven deals launched in 2015 finished higher than their offering prices at the end of December.

A downward spiral?

The ways in which private companies have funded themselves can compound the downside risks in an environment where expectations are waning. In many cases, strategic and late-stage investors have special terms, including liquidation preferences and anti-dilution rights, or hold preferential share classes, that are designed to protect their interests if the company in question is sold or raises funding at a level that is below prior valuations.

But such protections can hurt other stakeholders. As the New York Times noted,

These two rights will pack a punch to the common shareholders. If the valuation goes down below the liquidation preference, the common shareholders will have their entire investments wiped out. Even if this does not happen, the anti-dilution rights will come out of the hide of the common shareholders.

The newspaper added that “a down round hits employees and founders hard, evaporating the worth of their hard-won shares.” Simply put, the affected firms could see an exodus of talent, feeding a death spiral from which there is little hope of an escape.

Some might view such an outcome as the worst-case scenario, and argue that while things have gotten ahead of themselves, a correction is not necessarily the beginning of the end. Then again, if conditions revert to what they were before money became ultra-easy, investors may decide that illiquid investments should trade at a discount. If so, the fallout could be ugly.

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.