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Why The 'Next Billion Dollar Startup' Is Not Always The 'Next IPO'

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The number of billion-dollar private companies has erupted to an all-time high. In an earlier blog post, we counted more than 80 private companies that have raised funding at valuations over $1.0 billion—more than double the number of companies in 2013 and just under the total for the last three years combined. In that context, it’s a salient point that our inaugural list is a “ Next Billion Dollar Startup” list, not “Next Public Company.”

With an average age of just under five years, our 25 companies are relatively young compared to the age startups typically reach before going public. From 2001-2004, the average age of a company at its public exit was 5.4 years, as you can see in the graph below. From 2009-2012, the average age was 7.9.

But that’s not to say that the high-priced, later stage startups that have come to dominate headlines are always public companies in private garb. There are a couple reasons why later stage companies with large price tags take longer to cross the private-public threshold.

First is that they’re more incentivized today than ever before not to cross it.

Reason #1: From a regulatory perspective, it’s easier to stay private.

The JOBS Act of 2012, the Global Analyst Research Settlement of 2003, and the SEC’s move towards decimalization in 2001 had the combined effect of reduced pressure on companies to go public and less incentive for underwriters to take smaller companies public, as Andreessen Horowitz partner and COO Scott Kupor details here.

And as late stage companies remain in the private markets, making a famine out of last year’s feast in U.S. listings, they don’t have to look far for support in the nest.

Reason #2: There is a seemingly infinite amount of available private capital.

Hedge funds and mutual funds have taken notice of recent venture-backed exit payouts (see Alibaba’s record-breaking $21.8 billion IPO). And they want in. According to Bloomberg Business, firms such as Wellington, T. Rowe Price, Fidelity, and others traditionally invested in the public markets have been noted to pay 15-18x projected sales for the year ahead in private funding rounds, compared with 10-12x five years ago. And they’ve participated in at least 37 pre-IPO funding rounds totaling about $5.6 billion from 2012 to 2014, according to IPO underwriter Pacific Crest Securities.

As a result of delayed IPOs and additional sources of capital, late-stage startups have seen explosive valuations and large fundraises in later financing rounds.

While seed and Series A prices remain slightly below their averages for the past 10 years (hovering around $10 million), the median valuation for later stage companies jumped 123% in 2014 to $270 million, according to VentureSource data. Late-stage valuations have risen at a 13% compound annual growth rate since 2001, and already in 2015, as of mid-March, 10 additional companies have raised capital at valuations greater than $1.0 billion.

Few would argue against the fact that late-stage financing rounds have become fiercely competitive and capital inflated. But some might point out that the capital from hedge funds and mutual funds isn’t really “new” or “unconventional.” Because companies are scaling faster, they’re achieving the same size in the private markets that companies would have achieved in the public markets in prior years—the money isn’t “new,” the argument goes. It’s just dipping into private markets rather than remain in the public realm.

One point of contention might be, however, that today’s billion-dollar, later stage companies and the public companies of a decade ago do have similar valuations. But that’s where the similarities end.

As Bill Gurley wrote in a recent blog post, it’s a potentially dangerous notion that late-stage private companies are as mature as a public company at a similar valuation. To start, these private companies haven’t undergone the scrutiny required of the IPO process; their hundreds of millions of dollars in late-stage financing push profitability further into the future; and investors’ special terms could complicate cap tables to the point that they turn off new investors, and an IPO becomes a company’s escape route.

But wherever you stand on the matter of late-stage companies’ maturity (in terms of their readiness to IPO), late-stage valuations are on par with those of public companies in the past (and in some cases more expensive than those of their public counterparts today), and they’re high enough for many to sound the bubble alarm.

But there’s an argument for rising valuations as well.

Reason #3: Tech is global, both in geography and industry.

Global markets are larger for tech companies today, and industry verticals have expanded in ways that weren’t possible 15-30 years ago. Compared to public companies at similar billion-dollar valuations in 1999, late-stage private companies today operate in twice as many industries (10 versus 22), including lodging (Airbnb), transportation (Uber), groceries ( Instacart ), music (Spotify), interior design (Houzz), and even space exploration (SpaceX). And as 500 Startups founder Dave McClure wrote recently, if private “unicorns” are overvalued, it’s because public “dinosaur” incumbents - if they don’t adapt sufficiently - are at that much risk of going extinct.

As the opportunity to deploy revolutionary technology has expanded into more industries and across a wider geography, so, too, have valuations pushed at the seams. And though they’re not quite at the level of the 80 plus “unicorns” parading through the venture market today, the 25 next billion dollar startups and their investors are already helping map technology’s next innovative industries.

Whatever your take on the matter, these companies and the entrepreneurs behind them are the next generation of technology, regardless if they’re also the next public companies.

Click here for more coverage on the Next Billion Dollar Startups.

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