For example, the Wall Street Journal reports speculation that enthusiasm is falling and valuations will soon be lowered. Tech industry bigwigs are warning startups to focus on “unit economics,” a euphemism for “actually making money.” Not a lot of tech companies are pursuing initial public offerings these days. The revelation that Theranos Inc., a medical testing startup, probably exaggerated the efficacy of its technology might turn out to be merely the most flagrant case of overhype.
Initially, the IPO drought looked like it was happening because private markets were so much more attractive — big mutual funds have been ponying up cash for equity in so-called unicorns, or startups valued at more than $1 billion. Tech IPOs that did go through tended to have poor returns — a signal of excess demand in the public markets.
But sentiment may be shifting, and public markets may no longer be willing to pay those premium prices. That would leave late-stage investors, like the aforementioned mutual funds, with the choice of accepting a writedown or holding onto illiquid private equity for a long time. Even if they take the second option, there will probably be a pullback in funding for tech startups.
If this happens, though, we shouldn’t be worried. Almost no one will be hurt very much by a drop in startup valuations.
Tech founders, of course, will take a hit. Instead of being billionaires, many of them will have to settle for being eight- or nine-figure multimillionaires. Others will go bust and try again, or go get jobs. Imperial dreams will be dashed, but that’s only to be expected in the high-risk startup world.
Mutual funds will get bruised if the tech sector takes a hit. But they won’t be hurt too badly, because they generally apportion only a relatively small percentage of their capital to “alternative” investments like venture capital. At worst they will have a year or two of blah returns. And since Main Street investors — your grandmother’s pension or your retirement account — usually only invest in tech startups indirectly, via these mutual funds, a tech bust won’t hit individual investors hard.
Venture capitalists won’t be in a bad way either. Early-stage VCs and angel investors got in on the ground floor, when equity was cheap, so even if companies are forced to take writedowns, they will probably still make money. Late-stage VCs will take more of a hit, but they often have what’s called liquidation preference, antidilution provisions and other safeguards to make sure they don’t lose too much in the event of a turn in the market. After a bust they will simply pick up and carry on doing their thing.