Karim Gillani is co-founder and general partner of Luge Capital
The public-market landscape for the new cohort of tech companies seems to be crumbling more and more every day. WeWork Co. Inc., Peloton, Uber Technologies Inc. and Lyft Inc. are not experiencing the elation of their initial public offerings that the founders dreamed about when they first started those businesses. WeWork, especially, has seen its business erode significantly from the US$96-billion valuation promised by their Goldman Sachs advisers. Even at a US$15-billion price tag, investors were not keen.
In the United States, the number of publicly traded companies is about half as many as there were 20 years ago. According to Statista, public offerings are also down from 486 in 1999, before the dot-com value creation evaporated, to 190 in 2018. Companies are choosing to stay private longer and investors are looking for other means of liquidity.
For years, the venture-capital firms (VCs) that backed these emerging tech businesses have demanded high growth (customer acquisition and revenue), sometimes at all costs. That usually means the companies are burning through more cash than they are bringing in the front door, often many multiple times more.
In the early stages of a company, that’s okay, because until a business reaches proper scalability, it’s perfectly acceptable to spend money on foundational expenses and ramping up customer acquisition. That’s why VCs exist. Over time, however, for a business to thrive, there needs to be a path to self-sustainability with scalable unit economics, along with high growth – that’s the real definition of a strong business. And for companies to experience the juicy multiples of the tech sector, they need to show that operating expenses stay relatively flat (or grow slightly) as revenue increases. It’s on this last point where most of the recent tech giants begin to fall down.
Public markets are a lot less forgiving than the feel-good private markets. VCs and private-equity firms will spend the time to build relationships with founders, get excited about long-term visions, talk about ideal growth strategies and may even project their own ideas of the business onto the management team. Private investors pay the high premiums that founders demand, usually because there is a public-listing potential that’s sure to deliver 100-times returns.
The formula has been simple for private investors: Attach yourself to massively growing companies and take the ride until the inevitable large liquidity event. It’s a matter of pattern recognition.
But now that formula is not working so well.
The public markets not only want to see growth but a true path to sustainability. Companies that are either listed on public exchanges or are pursuing a public offering need to demonstrate that the business can function and grow, long-term, without the need for significant outside capital.
In the second quarter of 2019, Uber reported losses of US$5.2-billion, the company’s largest-ever quarterly loss. If you remove its stock-based compensation, it still lost US$1.3-billion. Lyft lost US$644-million for the same quarter. If I told you that for every dollar I made in revenue, I would seek out four more dollars from outside investors and burn all five dollars, how would you react? What if I told you that burn rate was going to increase with no end in sight?
Private investors, on the other hand, are much more tolerant of quarter-over-quarter losses, as long as the top line moves sharply up and to the right. After Xoom Corp., the global money-transfer company, was publicly listed on the NASDAQ, I led the corporate-development practice, which served as a catalyst for consolidation conversations with some of our smaller competitors with high growth rates.
Founders of still-private companies would sit across the table and explain to me with a straight face why their company, with one-tenth our revenue, a fraction of our customer base, large negative earnings before interest, tax, depreciation and amortization (EBITDA) figures and almost no balance sheet, was worth more than our modest market cap. Their justification? “That’s what our investors are willing to pay.”
We’ve systematically created a culture where the basic rules of Microeconomics 101 don’t apply, and enterprise value is the result of optimizing for growth on the revenue side of the income statement. Unless we recalibrate and return to first principles, we’re in for a bumpy ride with more botched IPO attempts and a market that is propped up by private investors who are sold on a vision with no maturity date.