Posts Tagged ‘bill gurley’

Above the Crowd

On the Road to Recap:

Why the Unicorn Financing Market Just Became Dangerous…For All Involved

In February of last year, Fortune magazine writers Erin Griffith and Dan Primack declared 2015 “The Age of the Unicorns” noting — “Fortune counts more than 80 startups that have been valued at $1 billion or more by venture capitalists.” By January of 2016, that number had ballooned to 229. One key to this population growth has been the remarkable ease of the Unicorn fundraising process: Pick a new valuation well above your last one, put together a presentation deck, solicit offers, and watch the hundreds of million of dollars flow into your bank account. Twelve to eighteen months later, you hit the road and do it again — super simple.

While not obvious on the surface, there has been a fundamental sea-change in the investment community that has made the incremental Unicorn investment a substantially more dangerous and complicated practice. All Unicorn participants — founders, company employees, venture investors and their limited partners (LPs) — are seeing their fortunes put at risk from the very nature of the Unicorn phenomenon itself. The pressures of lofty paper valuations, massive burn rates (and the subsequent need for more cash), and unprecedented low levels of IPOs and M&A, have created a complex and unique circumstance that many Unicorn CEOs and investors are ill-prepared to navigate.

Many have noted that the aggregate shareholder value created by all of the Unicorns will vastly overshadow the losses from the inevitable failed unicorns. This likely truism is driven by the clear success of this generation’s transformational companies (AirBNB, Slack, Snapchat, Uber, etc). While this could provide some sense of comfort, most are not exposed to a Unicorn basket, and there is no index you can buy. Rather, most participants in the ecosystem have exposure to and responsibility for specific company performance, which is exactly why the changing landscape is important to understand.

Perhaps the seminal bubble-popping event was John Carreyrou’s October 16th investigative analysis of Theranos in the Wall Street Journal. John was the first to uncover that just because a company can raise money from a handful of investors at a very high price, it does not guarantee (i) everything is going well at the company, or (ii) those shares are permanently worth the last round valuation. Ironically, Carreyou is not a Silicon Valley-focused reporter, and the success of the piece served as a wake-up call for other journalists who may have been struck by Unicorn fever. Next came Rolfe Winkler’s deep dive “Highly Valued Startup Zenefits Runs Into Turbulence.” We should expect more of these in the future.

In late 2015, many public technology companies saw a significant retrenchment in their share prices primarily as a result of a reduction in valuation multiples. A high performing, high-growth SAAS company that may have been worth 10 or more times revenue was suddenly worth 4-7 times revenue. The same thing happened to many Internet stocks. These broad-based multiple contractions have an immediate impact on what investors are willing to pay for the more mature private companies.

Late 2015 also brought the arrival of “mutual fund markdowns.” Many Unicorns had taken private fundraising dollars from mutual funds. These mutual funds “mark-to-market” every day, and fund managers are compensated periodically on this performance. As a result, most firms have independent internal groups that periodically analyze valuations. With the public markets down, these groups began writing down Unicorn valuations. Once more, the fantasy began to come apart. The last round is not the permanent price, and being private does not mean you get a free pass on scrutiny.

At the same time, we also started to see an increase in startup failure. In addition to high profile companies like Fab.com, Quirky, Homejoy, and Secret, numerous other VC-backed companies began to shut their doors. There were in fact so many that CB Insights started a list. Layoffs have also become more prevalent. Mixpanel, Jawbone, Twitter, HotelTonight and many others made the tough decision to reduce headcount in an attempt to lower expenses (and presumably burn rate). Many modern entrepreneurs have limited exposure to the notion of failure or layoffs because it has been so long since these things were common in the industry.

By the first quarter of 2016, the late-stage financing market had changed materially. Investors were becoming nervous and were no longer willing to underwrite new Unicorn-level financings at the drop of a hat. Moreover, once high-flying startups began to struggle on the fundraising trail. In Silicon Valley boardrooms, where “growth at all costs” had been the mantra for many years, people began to imagine a world where the cost of capital could rise dramatically, and profits could come back in vogue. Anxiety slowly crept into everyone’s world.

About this same point in time, the journalists that focus specifically on the venture capital industry noted something quite profound. In 1999, record valuations coexisted with record IPOs and shareholder liquidity. 2015 was the exact opposite. Record private Unicorn valuations were offset by increasingly fewer and fewer IPOs. If 1999 was a wet (read liquid) bubble, 2015 was a particularly dry one. Everyone was successful on paper, but in terms of real cash-on-cash returns, there was little to show. In Q1 of 2016 there were zero VC-backed technology IPOs. Less than one year since declaring it the “Age of the Unicorns,” Fortune Magazine was back with a dire warning, “Silicon Valley’s $585 Billion Problem: Good Luck Getting Out.

As we move forward, it is important for all players in the ecosystem to realize that the game has changed. Equally important, each player must understand how the new rules apply to them specifically. We will start by highlighting several emotional biases that can irrationally impact everyone’s decision making process. Next we will highlight the new player in the ecosystem that is poised to take advantage of these aforementioned changes and emerging biases. Lastly, we will then walk through each player in the ecosystem and what they should consider as they navigate this brave new world.

Emotional Biases

When academicians study markets, one common assumption is that the market participants will act in a rational way. But what if the participants are in a position that leads them to non-optimal and potentially irrational behavior? Many biases bring irrationality to the Unicorn fundraising environment:

  1. Founder/CEO — Many Unicorn founders and CEOs have never experienced a difficult fundraising environment — they have only known success. Also, they have a strong belief that any sign of weakness (such as a down round) will have a catastrophic impact on their culture, hiring process, and ability to retain employees. Their own ego is also a factor – will a down round signal weakness?  It might be hard to imagine the level of fear and anxiety that can creep into a formerly confident mind in a transitional moment like this.
  2. Investors — The typical 2016 VC investor is also subject to emotional bias. They are likely sitting on amazing paper-based gains that have already been recorded as a success by their own investors — the LPs. Anything that hints of a down round brings questions about the success metrics that have already been “booked.” Furthermore, an abundance of such write-downs could impede their ability to raise their next fund. So an anxious investor might have multiple incentives to protect appearances — to do anything they can to prevent a down round.
  3. Anyone that has already “banked” their return — Whether you are a founder, executive, seed investor, VC, or late stage investor, there is a chance that you have taken the last round valuation and multiplied it by your ownership position and told yourself that you are worth this amount. It is simple human nature that if you have done this mental exercise and convinced yourself of a foregone conclusion, you will have difficulty rationalizing a down round investment.
  4. A race for the exits — As fear of downward price movement takes hold, some players in the ecosystem will attempt a brisk and desperate grab at immediate liquidity, placing their own interests at the front of the line. This happens in every market transition, and can create quite a bit of tension between the different constituents in each company. We have already seen examples of founders and management obtaining liquidity in front of investors. And there are also modern examples of investors beating the founders and employees out the door. Obviously, simultaneous liquidity is the most appropriate choice, however, fear of price deterioration as well as lengthened liquidity timing can cause parties on both sides to take a “me first” perspective.

The Sharks Arrive With Dirty Term Sheets

Who are the Sharks?  These are sophisticated and opportunistic investors that instinctively understand the aforementioned biases of the participants and know exactly how to craft investments that can exploit the situation. They lie in wait of these exact situations, and salivate at the opportunity to exercise their advantage.

“Dirty” or structured term sheets are proposed investments where the majority of the economic gains for the investor come not from the headline valuation, but rather through a series of dirty terms that are hidden deeper in the document. This allows the Shark to meet the valuation “ask” of the entrepreneur and VC board member, all the while knowing that they will make excellent returns, even at exits that are far below the cover valuation.

Examples of dirty terms include guaranteed IPO returns, ratchets, PIK Dividends, series-based M&A vetoes, and superior preferences or liquidity rights. The typical Silicon Valley term sheet does not include such terms. The reason these terms can produce returns by themselves is that they set the stage for a rejiggering of the capitalization table at some point in the future. This is why the founder and their VC BOD member can still hold onto the illusion that everything is fine. The adjustment does not happen now, it will happen later.

Dirty term sheets are a massive problem for two reasons. One is that they “unpack” or “explode” at some point in the future. You can no longer simply look at the cap table and estimate your return. Once you have accepted a dirty offering, the payout at each potential future valuation requires a complex analysis, where the return for the Shark is calculated first, and then the remains are shared by everyone else. The second reason they are a massive problem is that their complexity will render future financings all but impossible.

Any investor asked to follow a dirty offering will look at the complexity of the previous offering and likely opt out. This severely heightens the risk of either running out of money or a complete recapitalization that wipes out previous shareholders (founder, employees, and investors alike). So, while it may seem innocuous to take such a round, and while it will solve your short term emotional biases and concerns, you may be putting your whole company in a much riskier position without even knowing it.

Some later-stage investors may be tempted to become Sharks themselves and start including structured terms into their own term sheets. Following through and succeeding at such a strategy will require these investors to truly embrace being a Shark. They will need to be comfortable knowing that they are adverse to and in conflict with the founders, employees, and other investors on the capitalization chart. And they will need to be content knowing that they can win while others lose. This is not for the faint of heart, and certainly is not consistent with the typical investor behavior of the past several years.

Let us now take a deeper dive into what this new fundraising environment means for each participant in the ecosystem.


Today’s Unicorn entrepreneur has been trained in an environment that may look radically different from what lies ahead. Here is the historic perspective. Money has been easy to raise. The market favors growth over profits. Competition also has access to capital. So, raise as much as you can as fast as you can, and be super-ambitious. Take as much market share as you can.

Never in the history of venture capital have early stage startups had access to so much capital. Back in 1999, if a company raised $30mm before an IPO, that was considered a large historic raise. Today, private companies have raised 10x that amount and more. And consequently, the burn rates are 10x larger than they were back then. All of which creates a voraciously hungry Unicorn. One that needs lots and lots of capital (if it is to stay on the current trajectory).

For the first time, perhaps in their lives, these entrepreneurs may face a situation where they cannot raise a clean incremental financing at a flat to up round. This is uncharted territory. There are a few alternatives:

  1. The first option available to many Unicorns today is a dirty term sheet. As discussed above, these terms can cleverly fool the inexperienced operator, because they are able to “meet the ask” with respect to cover valuation, and the accepting founder does not realize the carnage that will come down the road. The only reason one would accept such a deal is to maintain valuation appearances that simply do not matter. Taking a terms-laden deal is like starting the clock on a time bomb. Your only option is to hit the IPO window as fast as possible (Note: Box and Square were able to thread this needle successfully), otherwise, the terms will eat you alive. The main problem is that you will never raise another private round again, as no new investor will want to live on top of the termy round. So you will be stuck negotiating with the lender that already proved they were smarter than you.
  2. Take a clean round at a lower valuation. This will seem like a massive failure to many modern entrepreneurs, but they should quickly adjust their thinking. Reed Hastings at Netflix raised money in a high profile down round as a public CEO. Every single public CEO has had days where the stock price falls — it is common and accepted. The only thing you are protecting is image and ego and in the long run they absolutely do not matter. You should be more concerned about the long-term valuation of your shares, and minimizing the chance that you have the whole thing taken away from you. Terms are the true Godzilla that should scare you to death. A down round is nothing. Get over it and move on. Option #2 is way better than option #1.
  3. Buckle down and do whatever it takes to get cash-flow positive with your current cash balance. This might be the most foreign of all the choices, as your board of directors has been advising you to do the exact opposite for the past four years. You have been told to be “bold” and “ambitious” and that there is no better time to grab market share. Despite this, the only way to be completely in control of your own destiny is to remove the need for incremental capital raises altogether. Achieving profitability is the most liberating action a startup can accomplish. Now you make your own decisions. It will also minimize future dilution. Gavin Baker, a high-profile portfolio manager at Fidelity has a message for Unicorn CEOs: “Generate $1 of free cash flow, and then you can invest everything else in growth and stay at $1 in free cash flow for years.  I get that you want to grow and I want you to grow, but let’s internally finance that growth by spending gross margin dollars rather than new dilutive dollars of equity.  Ultimately, internally financing growth is the only way to control your own destiny rather than being at the mercy of the capital markets.”
  4. Go public. In the long run, the very best way for founders to look after their own ownership as well as that of their employees is to IPO. Until an IPO, common shares sit behind preferred shares. Most preferred shares have different types of control functions and most of them have a senior preference over common. If you really want to liberate your own common shares and those of your employees, then you want to convert the preferred to common and remove both the control and the liquidation preference over your shares. Many founders have been erroneously advised that IPOs are bad things and that the way to success is to “stay private longer.” Not only is an IPO better for your company (see Mark Zuckerberg and Marc Benioff on this subject), but an IPO is the best way to ensure the long-term value of your (and your employees’) shares.

It is worth noting that stock prices go up and stock prices go down. There is not a single high-profile public company that has been able to avoid time periods where their shares underperformed. Amazon went from $106 to $6 as a public company. Salesforce went from $16 to $6 and stayed below $10 for many months. Netflix went from $38 to $8 in six months. Remember Facebook’s first six months as a public company?

If you cannot handle a down valuation you should seriously consider abandoning the CEO position. Being a great leader means leading in good times as well as tough times. Taking a dirty deal is jeopardizing the future of your company, solely because you are afraid to lead through difficult news.


The explicit details of the capital structure of a company are typically obfuscated from the average employee. You know you work for a Unicorn, and you know you have some common shares. You might also know what percentage you own. And unfortunately, you may assume that the product of your Unicorn valuation and your percentage ownership is what you are worth. Of course, for that to be true, you need to reach a liquidity event (IPO or M&A) at or above the last round valuation with no incremental dilution from new rounds. But guess what: M&A is scarce (no large company wants to pay these prices or absorb these burn rates), and many founders have been told IPOs are bad. So how will you ever get liquid?

For the most part, employees are in the exact same position as founders (above), with the exception that they don’t participate in the decision tree outlined above in 1-4. That said, they should be asking the exact same questions of management:  Can we get to break-even on the money we have?  Do we need to raise more money?  If so, ca we do it on clean terms (vs. dirty)?  Employees should want to know if the founder/CEO would/did take a dirty deal, because common is at the most risk in such a situation. And then you should want to know if your leader is anti-IPO. If your CEO/founder will take a dirty round, and is also anti-IPO the chance that you will ever see liquidity for you shares anywhere near what you think they are worth is very, very low. You should probably move on to another company.


Disclosure: It should be noted that the author of the article and his investment firm reside in this category.

For the most part, early investors in Unicorns are in the same position as founders and employees. This is because these companies have raised so much capital that the early investor is no longer a substantial portion of the voting rights or the liquidation preference stack. As a result, most of their interests are aligned with the common, and key decisions about return and liquidity are the same as for the founder. This investor will also be wary of the dirty term sheet which has the ability to wrestle away control of the entire company. This investor will also have sufficient angst about the difference between paper return and real return, and the lack of overall liquidity in the market. Or at least they should.

The one exception to this is the late-stage investor or the deep-pocketed investor who may represent a substantial part of the overall money raised. This particular type of investor may have protected their ownership through the use of active pro-rata or super pro-rata investing. They may have even encouraged the aggressive “spend-to-win” mentality knowing that they can keep writing checks. They have been acting like a loose-aggressive player at a poker table.

There are two forces which have began to slow down this type of investor. First, as failure has begun to arrive on the scene, these investors have suffered some really big write-offs. These spectacular losses result in a lack of confidence not only for the investor, but more importantly for their LPs. The second problem is that for many of these investors, a single holding can become too large relative to the overall fund. They basically cannot afford to expose themselves to any more risk in a particular name. They use euphemisms to describe having over-eaten such as “fully allocated” or “at capacity.”

This form of big investor indigestion has created a really bizarre and unprecedented activity in the Unicorn world. High-profile investors, who are already armed with plenty of capital, have resorted to hitting the phone banks to solicit others to pile in behind them in their names. The voracious Unicorns need even more capital than these big-boys can afford. Ironically, if you look at the big historic wins of this investor class, there is no record of sending out Evites to other investors. But now they “need” others, which should signal risk to all parties involved. More on this later.

Investors also have to worry about raising their next fund, which can lead to unusual behavior that is independent of each individual company’s situation.  Do you support the dirty term sheet because this allows you to keep your paper-mark and not spook your investors?  Even though you know this may be bad for the company in the long run?  Do you feel the need to raise more capital quickly before the prices erode further and bring down your IRR? Do you feel the need to have more money to keep feeding the cash hungry companies you have already funded?


LPs are the large pools of capital, such as endowments and foundations, that invest in VC firms, hedge funds and the like. They are the real capital that make the system work. LPs evaluate the performance of the different investors in the ecosystem and make decisions about whether to fund their next effort or not. It’s a difficult job because the feedback cycles are so long — especially when it comes to investing in illiquid assets like startups (and Unicorns).

Another big challenge for LPs is that they are asked to measure the performance of these illiquid assets even though doing so is quite difficult and may not be indicative of future real cash returns. In this case, many LPs have incorporated the high performance of Unicorn valuations into their overall results which has created very strong performance gains for the venture capital category. In a sense they have already “banked” the gains. The problem obviously is that the lack of any material liquidity in the market combined with the recent correction creates a risk that they may not see the actual cash returns for the paper gains they already booked.

Furthermore, as mentioned earlier, they may face increased solicitation from VC firms who want to accelerate their fundraising process in the middle of this highly anxious environment. A recent WSJ article, “Venture-Capital Firms Draw a Rush of New Money,” highlights that VC firms are raising new funds from LPs at the highest rate in 15 years, even though cash liquidity is sitting at a seven-year low. A few sentences from the article are worth republishing here:

  • In recent years venture firms have written bigger checks and encouraged companies to spend to battle for market supremacy.  That left some venture firms short of cash, requiring them to raise money sooner than in years past to continue reaping fees and making new investments.
  • Some venture capitalists say the fundraising spike is timed to ensure that paper gains on startup investments still look attractive.
  • Cash distributions are what matter at the end of the day, but big paper gains still make for good fundraising pitches.

In addition to these issues, there has also been an increase in “inside rounds” where investors write new checks into companies where they are already investors, avoiding the “market check” that might have resulted in a potentially down valuation. This activity, which has an obvious conflict of interest, makes the LP’s job of judging VC performance even more difficult.

Against this difficult backdrop, many firms are asking their LPs to make new accelerated commitments to their next fund, exactly when evaluation is most difficult and anxiety may be at a cyclical peak. Moreover, deep down most LPs know that performance in the VC sector is counter cyclical to the amount of money raised by VCs. If you over-fund the industry, aggregate returns fall. Writing huge checks to bloated multibillion dollar VC funds could easily exacerbate the problems that already exist.

One response from the LP community might be to demand commitments from new funds that prohibit inside-led rounds and cross-fund investing. This can help to ensure that new capital is not put to use in an attempt to save previous investment decisions — an activity known as “throwing good money after bad.”

If this were not enough, some LPs are also being solicited to participate in SPVs (Special Purpose Vehicles), frequently from the very funds they have backed. As discussed earlier, some investors have reached a stage when they are overcommitted to a particular company in a particular fund (“at capacity”). Yet these investors want to keep providing capital to their Unicorns and support a growth-over-profits attitude. So they create a one-time special purpose investment vehicle (while greedily asking for even more carry). And the SPV has the added risk that is has no portfolio diversification or “look-back” feature to provide downside protection.

Obviously the LPs can just say “no” to participating in the SPV (even though they may feel the pressure of obligation from the fund). This is likely the smart move. First, someone is asking you to write a check at the exact time everyone else is overcommitted.  Hey, come help us out, we are drowning over here!  Second, you already have ample exposure to this exact company, through your original investment. Lastly, it is quite unlikely that a historical study of peak-cycle SPV participation shows good returns.


If you have a large pool of money and you haven’t been approached to invest in a Unicorn, it’s simply because people do not know where to find you. There are three types of people who are likely now approaching you, all of whom you should engage with quite carefully:

  1. SPV promoters – As mentioned in the section on LPs, investors have also broadened their SPV marketing more broadly to family offices and other pools of capital. The pitches typically involve phrases such as “you are invited to” or “we will provide access to” an opportunity to invest. This “you are so lucky to have this opportunity” pitch is eerily Madoffian. And remember, this solicitation is coming from investors who actually have money, but already know they are overcommitted.
  2. Brokers and 3rd-tier investment banks promoting the sale of secondary shares in Unicorn companies – If you ask any large family office, they will tell you they are being bombarded with calls and emails offering secondary positions in Unicorn companies. Often with teasers such as “20-40% discount to last round price.”
  3. Incremental Unicorn round – You might also be called on simply to pump more capital into a standard Unicorn round. With many investors “at capacity” due to the historic amounts of capital already raised, some companies are looking under any and every rock they can for more dollars.

One of the shocking realities that is present in many of these “investment opportunities” is a relative absence of pertinent financial information. One would think that these opportunities which are often sold as “pre-IPO” rounds would have something close to the data you might see in an S-1. But often, the financial information is quite limited. And when it is included, it may be presented in a way that is inconsistent with GAAP standards. As an example, most Unicorn CEOs still have no idea that discounts, coupons, and subsidies are contra-revenue.

If an audit is included, it might have massive “qualifications” where the auditor lists all the reasons that this particular audit may not comply with GAAP standards and that things could change materially if they dig in deeper. Investors need to really open their eyes to the fact that these are not IPOs. The companies have not been scrubbed in the same way, and the numbers they are looking at on a PowerPoint deck are potentially erroneous. Here is a recommendation: If you are about to write a multimillion dollar check for an incremental Unicorn investment, ask to speak to the auditor. Find out exactly how much scrutiny has been applied.

New potential investors might also be surprised how few Unicorn executives truly understand their core unit economics. One easy way to spot these pretenders is that they obsessively focus on high level “gross merchandise value” or “multi-year forward bookings” and try to talk past things like true net revenue, gross margin, or operating profitability. They will even claim to be “unit profitable” when all they have really done is stopped being gross margin negative. These companies will one day need real earnings and real profits, and if the company does not proactively address this, you should not be giving them millions of dollars in late stage financings.

Perhaps the biggest mistake untapped investors will make is assuming that because there are branded investors already in the company, that the new investment opportunity must be of high quality. They use the reputation of the other investors as a proxy for due diligence. There are multiple problems with this shortcut. First, these investors are “pot committed.” They invested a long time ago, and without your money their investment is “at risk.” Second, as discussed, they are already full and nervous. They didn’t call you before when they built their reputation.  Why are they friendly now?

The main message for investors who are just now being approached is the following: it’s not the second inning or even the sixth, it’s the fourteenth inning in a five-hour baseball game. You are not being invited to a special dance, you are being approached because you are the lender of last resort. And because of how we meandered to this place in time, parting with your dollars now would be an extremely risky move. Caveat emptor.

SEC Visits Silicon Valley

A few weeks ago, on March 31, 2016, the Chair of the SEC made a trip to Silicon Valley and gave a speech at an event at Stanford Law School. For those that are participating in Unicorn investing or for those considering investing in Unicorns, it would be a good idea to read the entirety of her presentation (which can be found here). Bloomberg’s interpretation of her presentation was that “Silicon Valley Needs To Corral Its Unicorns.

Chair White seems quite aware of the issues and pressures that have an ability to distort the Unicorn fundraising process:

Nearly all venture valuations are highly subjective.  But, one must wonder whether the publicity and pressure to achieve the unicorn benchmark is analogous to that felt by public companies to meet projections they make to the market with the attendant risk of financial reporting problems.

And then she sends a message to all former and future investors regarding the need for increased due diligence:

As I will discuss, the risk of distortion and inaccuracy is amplified because start-up companies, even quite mature ones, often have far less robust internal controls and governance procedures than most public companies.  Vigilance by private companies about the accuracy of their financial results and other disclosures is thus especially critical.

It would be quite unfortunate if the fundraising behavior of the Unicorn herd led to increased SEC involvement and rules with respect to private venture-backed startups. But if those involved believe that “not being public” also means “not being responsible,” we will quickly find ourselves in that exact place. We will have deservedly invited more scrutiny.

Mo Money Mo Problems

Perhaps the biggest lapse in judgment for all of those involved is the assumption that if we can just raise “one more round” everything will be fine. Founders have come to believe that more money is better, and the fluidity of the recent funding environment has led many to believe that heroic fundraising is a competitive advantage. Ironically, the exact opposite is true. The very best entrepreneurs are relatively advantaged in times of scarce capital. They can raise money in any environment. Loose capital allows the less qualified to participate in each market. This less qualified player brings more reckless execution which drags even the best entrepreneur onto an especially sloppy playing field. This threatens returns for all involved.

The reason we are all in this mess is because of the excessive amounts of capital that have poured into the VC-backed startup market. This glut of capital has led to (1) record high burn rates, likely 5-10x those of the 1999 timeframe, (2) most companies operating far, far away from profitability, (3) excessively intense competition driven by access to said capital, (4) delayed or non-existent liquidity for employees and investors, and (5) the aforementioned solicitous fundraising practices. More money will not solve any of these problems — it will only contribute to them. The healthiest thing that could possibly happen is a dramatic increase in the real cost of capital and a return to an appreciation for sound business execution.

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Silicon Valley TechFlash
Benchmark VC Bill Gurley warns winds are shifting on unicorn valuations


Cromwell Schubarth Senior Technology Reporter Silicon Valley Business Journal

Bill Gurley, a general partner at the Benchmark venture firm, sounded another alarm Thursday night about soaring valuations of VC-backed businesses.


Bill Gurley, a general partner at the Benchmark venture firm, sounded another alarm… more

Venture investor Bill Gurley sounded another warning about the high valuations at venture-backed companies in an overnight tweetstorm on Thursday.

Volatile global stock markets are going to put pressure on CEOs at the growing crop of VC-backed businesses known as “unicorns” that are valued at $1 billion or more, the Benchmark partner said.

That is going to increase pressure to produce a profit or show how one will come, Gurley said, tweeting,”Which Unicorn entrepreneurs/CEOs are prepared for such a shift? Who can adjust quickly? Can you get to profitability on your last round? Have you even considered such a reality?”

This isn’t the first time that Gurley has warned of a pending correction in soaring valuations that profitless venture-backed companies have been getting. He predicted in an appearance at South by Southwest in March that we may see some dead unicorns in 2015.

The shift in focus by public investors to concerns over profits from excitement about rapid growth is a key reason that tech IPOs slowed dramatically since early last year. A number of venture-backed companies that had been expected to go public by now have instead raised IPO-sized funding from late-stage investors at lofty valuations.

Investment research firm CB Insights reported this week that the number of unicorns in the world has grown to 123 and they have a combined valuation of $469.1 billion. It added that their aggregate worth tops the valuation of every company on the Nasdaq 100 except for Apple, which is valued at more than $660 billion.

But LinkedIn co-founder and Greylock Partners VC Reid Hoffman argued in a blog last weekend that, while some valuations are certainly too high there, there are good reasons to believe that others will be validated eventually on Wall Street. He wrote that the term “unicorn” has created a mistaken belief that these valuations aren’t real.

“While the metaphor may put an implied cap on the number of billion-dollar companies that can credibly exist, VC firms and other investors are betting on technology, not metaphors,” Hoffman wrote in a blog posted to LinkedIn over this past weekend.

Gurley’s not buying that, though, apparently. He points to big drops in some prominent tech stocks and on Chinese markets in the past six weeks.

“The bottom line is that global tech valuation multiples are compressing (coming in). Quickly,” he tweeted Thursday night. “One might reasonably assume that this would have an adverse impact on late stage private market liquidity and valuation. I certainly do.”

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Which billion-dollar ‘unicorn’ startups are at most risk of dying? Here’s what some data suggests …

Unicorn maskFlickr/perhapstoopink

There’s been a lot of talk about tech unicorns recently.

A unicorn is a term used to describe a startup worth $1 billion or more. Like the fictional animal, unicorn companies are supposed to be rare and magical.

Lately, tech’s unicorns have become rather common. Last month, the Wall Street Journal compiled its own “billion-dollar club” — a list of 78 venture-backed private companies with valuations of $1 billion or more.

When a company hits a billion dollar valuation, most people assume the company is stable and on a clear path to sustainable success.

But at a SXSW keynote a few weeks ago, Benchmark Capital’s Bill Gurley warned that Silicon Valley’s optimism could eventually lead to the demise of some of these unicorn companies.

“I do think you’ll see some dead unicorns this year,” he said.

One week later, Sequoia partner Michael Moritz chimed in and stated, “There are a considerable number of unicorns that will become extinct.”

So, which of today’s tech unicorns could be at risk?

We reached out to a dozen venture capitalists to see which unicorns are most at risk of dying. Nobody was willing to name names. (Wimpy!)

So, we turned to Danielle Morrill, CEO and cofounder of Mattermark, which tracks all sorts of data about private companies. Mattermark examines the number of employees a company has, how much money a company has raised, a website’s estimated number of monthly unique visitors, app downloads, and more. Investors use Mattermark to keep tabs on startups.

Mattermark collects data from a number of sources, including but not limited to: AngelList, Alexa.com rankings, app store rankings, anonymous sources, and social media.

When investors started predicting the death of unicorn startups, Morrill went data diving.

“VCs love to say this stuff, but they never actually say who [the dead unicorns are],” Morrill says. “So I was thinking: how would you figure out which companies were really in danger? We have some really interesting data that we track that can give you some sense of how they’re doing.”

bill gurleyDavid Paul Morris/Bloomberg via Getty ImagesBill Gurley, the man who has been ringing the alarm bells about startup valuations.

The warning signs

The companies Morrill pays the most attention to are consumer-facing, low-margin companies that need to get people online and using their services without spending too much on customer acquisition. To identify companies that could be in trouble, Morrill first looked at companies whose employee base has stopped growing or started shrinking.

“I was having a conversation with someone from a company that caters toward startups and she said, ‘If their employee count starts to drop, very rarely does it come back around and start to grow again.’ And that’s very interesting. If you track employee count at a granular level, you can see the six-month and one-year change in employees,” Morrill said.

“So you look at some of these unicorn companies and you can see their employee count is kind of flat, or even maybe declining a lot or a little. And that’s a really bad sign because to IPO your company, you still have to be growing pretty fast from a company perspective. Generally to grow revenue you have to hire more people. It’s pretty uncommon to find some magical place where you can stop hiring people and your revenue still grows 100% year over year.”

Danielle Morrill mattermarkDanielle Morrill/LinkedInDanielle Morrill is the founder of Mattermark, a company that tracks private companies’ data.

The second major dead unicorn warning sign Morrill looks for: how are a company’s social media mentions trending? If mentions increase and web traffic from social sites increase, then a company may be spending more on marketing. A drop in web traffic or social media mentions could indicate marketing budget has been chopped to decrease burn, or general interest in the startup is waning.

Morrill emphasized that unicorns with these warning signs may not be “dead,” per se, but that they’re going to really struggle to find their next infusion of cash in a down market. “In 1999 or 2000 they would have tried to go public on the Internet company hype, but that probably won’t work now,” she said. “The B2B ones can find buyers, though not necessarily at valuations matching their last rounds. The consumer ones, especially with very low margins, could be in a lot of trouble.”

To help us identify at-risk unicorns, Morrill looked at a list of companies that fit the following criteria:

  • Haven’t exited
  • Have raised $100 million or more
  • Employee count growth in the past 6 months is 5% or less (many are negative)
  • Have raised new funding in the past 36 months

Not all of the companies that fit these criteria are unicorns, so we whittled it down to only show companies with billion-dollar valuations.

From there, we took a look at the companies on Mattermark’s data platform with the lowest growth scores and Mindshare scores — a proprietary ranking algorithm that takes into account factors including estimated downloads, web traffic and social media numbers. A negative or low Mindshare score can indicate declining customer interest in a company.

To be clear, the only reason a company ever goes bust is that it runs out of cash. So, while we’re looking at user numbers, and downloads, the only that really matters is how much cash is in the bank. And that’s something Mattermark doesn’t know.

Things don’t look good for these unicorns

Based on Mattermark’s data, these unicorns could be most at risk:

Gilt Groupe

The flash-sales website was anticipated to be one of the buzziest e-commerce companies in the world. It generated hundreds of millions of dollars in revenue. Now, though, it has downsized and it is struggling to maintain that growth. A recent fundraising round indicates Gilt, which is valued at $1.1 billion after raising $286 million in funding from investors including General Atlantic, Matrix Partners, and TriplePoint Capital, will probably continue to delay an IPO.

Gilt Groupe did not return a request for comment for this story.

Gilt’s estimated downloads on iTunes spiked in May 2014, but have decreased since then:


Gilt’s available job listings are up from December 2014, but have decreased month over month.


Gilt’s employee count has declined since December.


Gilt’s social mentions on Facebook have declined, as have its inbound links:GIlt3Mattermark



You may have never heard of it, but VANCL is a Chinese online retailer that sells men’s and women’s clothes and shoes. According to the WSJ, it’s valued at $3 billion after raising $512 million from investors including IDG Capital Partners, Temasek Holdings, and Tiger Global Management.

The company was supposed to go public in 2011, but didn’t, and it’s since raised another $100 million with no announced plans to IPO.

VANCL did not return a request for comment for this story.

VANCL’s employee count has declined since early 2014:

vancl chart mattermark

VANCL’s estimated monthly uniques have declined, according to Mattermark:vancl chart mattermark

These unicorns may also be at risk

There are some other big, billion-dollar names on the list, though their growth scores are higher and don’t indicate as much risk. Some of the buzzier companies among them include Spotify, Jawbone and Evernote.


Here’s Spotify’s open jobs history over the past year and a half. According to Mattermark data, it has declined.


Spotify’s inbound links are up from November 2014, but still down from September 2014.SpotifyMattermark

When reached for comment, Spotify said Mattermark’s numbers weren’t correct, but did not offer more correct figures.

After publishing, Spotify clarified some figures that counter Mattermark’s data and point to strong growth. Specifally, the company says its active users and download growth looks like this:

  • March 12 2013 – 6,000,000 subscribers/24,000,000 active users
  • May 21 2014 – 10,000,000 subscribers/40,000,000 active users
  • Nov 11 2014 – 12,500,000 subscribers/50,000,000 active users
  • Jan 7th 2015 – 15,000,000 subscribers/60,000,000 active users

“This data from Mattermark would be a real problem if it was 1999, but since it’s 2015 and 85% of our new users come from mobile we’re not too concerned about inbound links to our website being flat,” Spotify spokesperson Graham James says.


Evernote shows declining inbound links from other sites as well as a decline in Facebook mentions.

Evernote declined to comment for this story.




Last of all, here are some charts from wearable company Jawbone:


It looks like Jawbone’s estimated monthly uniques peaked in December or January, and have been declining since then.

jawbone mattermarkMattermark

Jawbone’s open jobs history, according to Mattermark, has declined.jawbone mattermarkMattermark

Inbound links to Jawbone are also declining, according to Mattermark.

We reached out to Jawbone for comment, but Jawbone did not comment on this story.

Looking at the data, we also found patterns of companies that could be in trouble.

  • Mattermark’s data suggests that a number of e-commerce companies could struggle.
  • The list contains a lot of biotech and energy startups. “They’re just struggling so much,” Morrill says. On a list of 241 potentially hurting companies, 77 were biotech, cleantech, or energy-related.

Morrill admits her criteria and list may not be perfect, but she hopes it will be eye opening for the startup community.

“Even if the list is not perfect, hopefully it gives people a place to look and be much more critical and conscious of what’s really going on,” she says.

So, there you have it. A list of some unicorns that some data suggests are at risk.

Disagree with this list? Think all these companies are in great shape and that some other unicorns are toast? Then tell us what you’re thinking and why.

Talk is cheap. If you’re going to predict that many billion-dollar companies are about to drop dead, don’t stop there. Name names!

Disclosure: Kevin Ryan and Dwight Merriman, the founders of Gilt Groupe, are investors in Business Insider.


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Hot shot startup investor Bill Gurley just wrote a cryptic tweet about the looming tech bubble — once you understand it, you’ll be a little freaked out

The other day, Bill Gurley, who has to be on the Top 5 most successful and smartest VCs, had a few semi-cryptic tweets. Cryptic to non-VCs, at least:

At our recent LP meeting, an LP told me industry wide distribution $ relative to paper value is at an all time low.

Wet bubbles (1999) are more fun than dry ones (2015).

Many of you may not even know what an LP meeting is. It’s where VCs meet with their own investors, the “Limited Partners.” And it might be a bit cryptic what this LP said to him.

But it’s very interesting, and here’s the actual data from Cambridge Associates (Thank You!), the leading industry analysts of VC data — albeit only through the end of ’12 (though as we’ll see below, nothing’s really changed since then):

venture capital unrealized valueSaaStr

There is even more VC industry lingo in here, but once you understand it, it’s quite interesting.

The top line, or “TVPI”, are paper mark-ups + cash back out (distributed capital). “DPI” on the bottom is just the actual cash back out. You can see the delta is quite, quite large.

What’s a paper mark-up? Well, some late-stage private market investor invests in my company at a $1 billion valuation. If I invested at a $10 million valuation, I get a 100x paper mark-up. I’m a hero at the firm. I brag. I run a pre-victory lap and tell myself how brilliant I am. That I see the future.


In this scenario, as brilliant as I look with my 100x mark-up…I’ve actually returned nothing in cash. No cash. Not a nickel. It’s a gain, yes — but on paper only. Until an IPO, or an acquisition, no cash goes back out. Sometimes a little goes back out in a so-called secondary sale, but even when it does, this is usually pretty small.

So the bottom line on this cash, DPI, is hard cash back out to the LPs.

And as you can see, there ain’t much cash going back out. In fact, DPI or “cash out” from VC funds hit rock bottom in ’12, and the gap between mark-ups and cash distributed is at an all-time maximum.

Bill GurleyFlickr/TechCrunchBill Gurley thinks there is a dry bubble.

Hence — Bill Gurley’s Dry Bubble. It’s a bubble in valuations. But there ain’t no cash. The bubble isn’t an IPO bubble, like Broadcast.com or GeoCities or TheGlobe. No cash is going back out to create the next Mark Cubans, at least not that much. At least not yet.

Now, some great IPOs in ’16 can “cure” this and generate cash back to those folks putting all this money into Unicorns. And many of the best companies are intentionally holding off on IPO’ing, taking time to grow faster without the scrutiny of Wall Street. This delta, this gap, may be temporary. An Uber IPO, an AirBnb IPO, etc. will boost that bottom line substantially. If every unicorn IPOs, all will be right in the world, and the Dry Bubble will become very, very Wet (i.e., cash rich) indeed.

You can see though that even with 2014 data, from this great A2Z prez below, the “gap” between private Unicorn $$$ (75% of investment) vs. “real” Unicorns (from an IPO or acquisition) is still quite high:

With 75% of invested capital trapped in private Unicorns (another way to look at it), that’s pretty dry.

So for now at least — it’s a roach motel. All this money is going in at higher, all time higher, valuations — but very little is coming back out.

The optimists believe it’s just a matter of time. But if you’re say the guy that sold Broadcast.com to Yahoo! for $5.7 billion…you might think this really is the driest of all bubbles, of all time.

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The technology industry is clearly prospering, but has it entered a period of irrational exuberance? There are good reasons to worry that it has and that the bursting of this bubble could be painful, to investors in and employees of tech firms as well as to the broader economy.

By several measures — stock prices, multibillion-dollar acquisitions, the compensation of employees, the money being spent by start-ups that have little revenue or profits — the technology industry is in a period that is starting to feel like the late 1990s. Even some industry elders who lived through the previous boom and bust, including the venture capitalists Marc Andreessen and Bill Gurley, are warning that Silicon Valley might be overheating.

There are, of course, differences between the current boom and the earlier one. Most tech companies that have gone public in recent years, like Facebook and Twitter, are more mature than companies that created a frenzy on the stock market some 15 years ago before fizzling out, like Pets.com and Webvan. Tech companies that go public these days are more likely to be profitable or at least have been in business long enough to have some kind of track record.

Stock market valuations, measured by long-term corporate earnings, are high by historical standards but much lower than they were in early 2000, according to data collected by Robert Shiller, the Yale economist. That should provide some comfort to investors, though not much. At the end of trading on Friday, the tech-heavy Nasdaq composite index was down 7 percent from its recent high last month.

The problems are not limited to publicly traded companies. Many privately held tech companies have such easy access to venture capital that they are spending lavishly and burning through cash without a clear plan for turning a profit. Office rents in San Francisco jumped 10 percent in the first nine months of this year, according to the CBRE Group, which estimates that rents in that city could be higher than rents in Manhattan by the end of 2015. In a series of tweets, Mr. Andreessen recently said that many tech start-ups would probably fail and have to fire employees. He ended by telling his followers, “Worry.”

Much more of the current tech boom is concentrated in Silicon Valley than it was in the late 1990s. About half of the $22.7 billion that venture capital firms invested in start-ups in the first six months of this year went to businesses located there. By contrast, Silicon Valley’s share of venture capital investments was less than 35 percent during the late 1990s, according to a PricewaterhouseCoopers report. This suggests that a tech downturn could be particularly bad for the economy of Northern California.

It’s impossible to predict with precision when business cycles will turn. But as many investors learned more than a decade ago, the valuations of companies can outstrip their ability to make money for only so long.

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