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The New (New) Rules Of Going Public

tl;dr: Hello friendly neighborhood unicorn, let’s talk about going public. 

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According to a recent EY report, there were zero technology IPOs in the United States during the first quarter of 2016. Even worse, global technology IPOs fell 24 percent during the same period. Given the bursting number of unicorn startups, the figures are troubling.

Just over a year ago, I wrote a mostly unkind piece entitled “The New Rules Of Going Public,” detailing commonalities between the public offerings of Box, New Relic, and Hortonworks. The similarities—as you could have guessed with your brain turned off—were briskly expanding top lines, continuing losses, and a history of heavy capitalization from private investors.

If that sounds like your favorite unicorn today, it’s because the analogy holds. And that’s precisely why I’m worried. Taking stock of the current IPO markets shows a dramatically changed set of expectations, while the startups that might, or should be prepared to approach a flotation are often of a prior mold.

In that vein, I want to explore how much the IPO market has changed for startup technology companies. I promise we are going to have fun. Also there is a special treat at the end. Off we go!

Past Performance, Future Results

The heady climate that gave us the 2015 crop of IPOs has cooled. That’s a polite way of saying the gap between the private and public markets is working to correct itself. At issue are stiffly set private valuations that differ from public expectations. Unspooling that delta is going to take time, and pain.

If I was being bold, I would posit that that issue is a key driver for why technology IPOs in the United States managed a flat zero so far in 2016.

In practice that means unicorns are trying to grow into their last private valuation so they can match it in the public markets, a task that is compounded by recent market uncertainty. Sum the mix and you have an environment in which both private companies and public investors are just fine canceling lunch.

That market uncertainty could be called sentiment, or expectation shift.

The change in investor expectation from early 2015 to 2016 is notable. Keep in mind that Box, New Relic, and Hortonworks all did manage IPOs. However, the trifecta have seen their share prices fall, even as their financial performance grew. Box, to pick an example, has consistently expanded its guidance and beaten it, but remains mired under its IPO price.

Here’s each companies’ first day close, to today’s trading price in terms of percent decline [Data via Google Finance]:

  • New Relic -28.98 percent
  • Box -47.48 percent
  • Hortonworks -60.2 percent

We are not here to be overly negative about past performance, but instead to detail how things have shifted. But, as the numbers imply, what was once good enough for an IPO in the high burn, high growth segment is now likely not; given those performances, it’s doubtful that financially analogous companies could go public today. Or, if they could, it would be a massively smaller valuation than their last.

What Is Good Enough?

The rules of going public as a concept came back to the forefront of my mind today as I published an interview yesterday with the CEO of a C-Stage company that will eventually go public. He brought up Nutanix as a company that, in his view, is top-notch, filed to go public, and has since put off a public offering.

Nutanix filed in December of 2015. As you can recall, things got a bit twisty during the opening of 2016, so the company would hold off its offering is perhaps not surprising. Let’s take a look, however, at its figures.

The company’s revenue growth expanded from $46.0 million in the third quarter of 2014 to $87.7 million in the third quarter of 2015 (The company has yet to file an amended S-1 document with updated figures). That’s a nearly 91 percent increase, which is very impressive.

On other the lower end of its income report, however, is something similar but in reverse. While its revenue increased greatly, so too did Nutanix’s net losses. The company lost $28.5 million in the third quarter of 2014, and $38.5 million in the third quarter of 2015, using GAAP metrics. That’s only a 35 percent increase, which is far smaller in terms of percentage growth than its revenue expansion.

And that, I presume, is why Nutanix thought it was time to go public. Yes, its losses were still rising, but given the far quicker growth in its revenue, the rising red ink wasn’t too much a problem. That was also true with our former trio, which later saw the market clip their wings while pursuing a similar strategy.

To be clear, I expect Box to reach profitability, and Nutanix to go public. But the market has changed its expectations and no longer has the appetite that it did for firms of their high burn, high growth model.

No I don’t know why, I just stare at charts all day.

Something Else

Another IPO winding its way towards the public markets is Acacia Communications, a Boston-based company that sells optics things that makes the cloud and Internet scoot along at high speeds. It’s old-school tech in that it isn’t an app that helps you find Pokemon on your commute using AR on your touch-enabled Google Glass replacement sourced from ambient wireless IR signals beamed to your Samsung tablet synced to your Apple Watch, but it still matters.

So here’s the thing. Acacia—here’s their Mattermark profile if you need a primer—filed its S-1 to go public in December of 2015 during the same week at Nutanix. It is moving a bit quicker, however, having recently re-filed its document with the SEC. The game is afoot, in other words.

So what are its numbers? It’s full-year revenue grew from $146.2 million in 2014 to $239.0 million in 2015. That’s pretty good. But here’s the kicker: The damn thing actually made more money as it grew. Acacia’s profit expanded from $13.52 million in 2014 to $40.5 million in 2015, on a GAAP basis. Who would have thought that possible?

And even with those figures the company had to delay its offering. What does that say about companies that are still comically unprofitable and hoping for another private tranche or public offering in the short term?

The rules have changed.

Amended Rules

None of this is to say that you can’t go public if you aren’t profitable, but it certainly seems that the loose ratio of your revenue growth to losses will need to be far higher. You need more growth and smaller losses than before to have any sort of hope.

I have one little guess I want to put down on paper for now. I think that companies that are showing quick revenue growth and continued losses will still be able to go public provided that their losses are in decline in raw dollar terms, and not merely in ratio to their revenue. It’s not just enough to have increasing margins; you actually have to lose fewer dollars. Of course, this will greatly impact your margins to the good over time. So the old rules from before are still applicable, just too kind for current realities.

Good luck, friendly neighborhood unicorn.

If it feels like we have spent quite a lot of time discussing public and private markets, it’s because we have. This is the natural result of how long we spent arguing over and writing about unicorn fundraising. We’ve reached a different part of the journey.

Now, I promised you a special treat, and I am not one to under-deliever. Here is something beautiful:

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Featured Image via Flickr user Geoff Livingston under CC BY-SA 2.0. Image has been cropped.
© Mattermark 2017. Sources: Mattermark Research, Crunchbase, AngelList.
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