Unicorns have bubbles? absolutely! But it's not a valuation bubble

Editor's note: Bill Gurley, the original author, is one of America's most famous investors, Benchmark's partner, whose company has invested in Uber, SnapChat, DropBox, WeWork and many other startups. At a time when experts are debating whether the "unicorn" is overvalued, he argues in a unique way, that there is a real bubble, but not a valuation bubble, but a "risk" bubble ...

In a successful technology company, financing will run through its entire life cycle. It usually starts with the seed phase and then into the A,b,c and "late" financing, and then, for those very successful companies, it should be the start of the IPO (initial public offering). Throughout the history of the investment community, traditionally, different financial institutions have focused on different stages of investment, as the risk assessment techniques and opportunity assessment techniques required at different stages are not the same-for example, a seed-phase investment financial institution is unlikely to have a late-stage (late-stage) investment and vice versa.

In recent years, the late investment market has become the most competitive and the most intensive investment stage in the many investment processes mentioned above. Investors around the world believe that late-stage investment is the place they want to play most. As a result, late-stage financing is no longer just for those overvalued, expecting profitable companies to prepare for the IPO, and it has evolved to represent a large, high-volume financing campaign. In recent years, more than 80 private companies have raised more than $1 billion in the so-called late-stage funding phase. These large-scale, high-volume unlisted corporate financing is a feature of this particular technology company's financing process (post-evolution late financing).

A lot of people argue that if investors were to make such a scramble and huge investment in these companies in the early years, they would have already been listed, and that would be the case for IPOs. In fact, this is not the case, it's all happening before the IPO. In fact, these entrepreneurs and investors are actually putting themselves in a very dangerous position. Only a small percentage of these companies are really ready to go public and meet the conditions of listing. This huge amount of private equity in the pre-IPO format is very different from the IPO. Figuring out these differences is really important for us to really understand the damage that has been caused by the huge, late-stage private capital that has gone bad.

Ironically, the last 2014 was the year of the highest IPO record. So many of these have made a huge investment, but actually not ready for the listing of the private enterprise is listed, in fact, this really does not have any benefits. The valuations of these companies may be similar to those of listed companies, but in fact they are the only similarities.
They are actually very different, the first and the other is that these late-stage private companies are simply not subject to high-intensity scrutiny. And a high-intensity review is exactly the process that an IPO must have. You need to know that an IPO requires a very rigorous process, which represents the most thorough process a company needs to walk through in its life cycle. That's why those listed companies and their shareholders are feeling the pain in the process-whether they're ready to go public or they're on the market when they are not ready at all. Auditors, bankers, all kinds of lawyers, during the period you don't forget. The Securities and Exchange Commission will take several months to investigate your business to ensure that every data you provide is accurate, that important risks must be determined, that the accounts must be completed, and that the development management of the enterprise must develop healthily. On the contrary, there is no such momentum and process in late-stage private placements, which may be done simply because of a PowerPoint presentation.

In the absence of an auditor's deep, rigorous and compact audit, investors will assume that the figures they see in private equity activities are just as accurate as the business financial information that has been rigorously and tightly accounted for before the IPO. In fact, many of these private-sector financial audits are procrastinating on the previous year's time, even if the time to submit the results of the accounting is approaching, in this case the auditor will not really roll up their sleeves like a real IPO began to do their best to audit. Because in the IPO process, the data they provide will be carefully audited by the Securities and Exchange Commission, and there is no such provision in the private placement process. As a simple example, many investors and entrepreneurs do not realize that the coupon and discount rate should not be counted as "revenue recognition", and you must subtract this part from your total revenue. In fact, many of the "rich" private consumer enterprises are generally using this market strategy, so their financial presentation in fact there are many such unreasonable accounts.

Without the bankers ' guidance, some companies may deviate from industry standards when presenting their financial position. As another example, let's take a look at some of the companies that offer trading markets, such as ebay and GrubHub, where their financial earnings reports are based on net income rather than revenue. And the start-ups are more focused on the total revenue, and you need to know that 80% of these total revenues are actually paid to the commodity suppliers. A good banker can easily point out the issue in the normal IPO process--as an investor, you should invest in net income, rather than several times as much as the net income.

The fact that tens of millions of dollars of money will be smashed into an immature private enterprise will also backfire on the operating principles themselves, but what about the results of these immature private companies, once they get such huge investments? It turns out that the only result is a loss of business! Let's look at past history and know that a company that is really going to be at the IPO level will be looking at the profitability of the business. But these immature private companies, when they get such a large amount of money, they will be the lack of urgency and will need to prove the profitability and market model these goals of slow progress.

We'll take fab.com this company to analyze it, in "Business Insider" in an article this February 6, Allyson Shontell found that the company in the acquisition of $48 million of funding 4 months after the founding of the company and The CEO disclosed to the employees that "we have successfully spent $20 million, and unfortunately we have failed to prove whether our business model is really viable." ”

To overcome these risks, the responsible person should be on the investor side. Investors should conduct a more in-depth study to examine all the economic factors in the underlying business. This requires investors to seriously analyze the real marginal gains in the business, rather than simply examining the gross and net revenue and other unrealistic measures of income, and not even looking at the gross margin that the firm gives. If you really want to know if the business model is really worth the competition, you have to be very cautious. Otherwise, you might end up just finding a company that sells $1 for $0.85 (editor's note: That means investors are investing in a worthless business).

Finally, there are some structural problems in the investment of the listed enterprises compared with the investment of private enterprises. Many private-sector financing processes involve clearing priority preference shares. This preferred stock with liquidation priority gives the investor a clause with a downside protection (downside protection) of the right to exit. When your business has made multiple fundraising in this form, the valuation of the firm will be very different, depending on the extent of the company's prior preference shares being cleared, which will affect subsequent investor investments. As these preferred shares accumulate more (preference shares vary in priority in different rounds), then new investors will worry about whether their real money is really worth the price, so they tend to ask companies to prescribe special terms to protect their rights, but it is ironic that These safeguards will further contrast the unfriendly friendliness of the investors they have come to, and it will complicate the company's real market capitalisation.

Ultimately, in order not to make the company's market capitalization vulnerable, the private sector has to go public when it is not fully ready. Once listed, all preferred shares will become common stock (Editor's note: The original author is only for the United States), so that all the liquidation priorities and other terms caused by the problem will disappear. In fact, the latest box.com so the IPO situation is a true portrayal of this aspect. The obvious irony here is that most of these companies are reluctant to use IPOs as their last straw. " Unfortunately, because they did not respect the normal steps towards an IPO, they eventually had to try to seize the last straw in anticipation of redemption.

All this suggests that we are not in fact a valuation bubble-and that is exactly what many mainstream media are now agreeing to. We are in fact now in an "Adventure bubble" (Risk Bubble) (Editor's note: Our investors ignore too much risk and blindly put too much money into the "late" round of financing, mistakenly putting a bubble in late-stage IPOs). At the same time, because of the above problems such as finance, enterprises in the investment after they have to burn a huge amount of money to compensate for these financial problems, which will further endanger the long-term development of these enterprises.

"Late" investors, who are extremely afraid of losing their chance to have a stake in a future "unicorn", have thrown the traditional formal risk analysis that they should have insisted on to Cloud nine. These are traditionally "early" investors, investment institutions, and millions of individuals who are scrambling to sprint to this risky "late" financing game.

Perhaps we should calmly think about a suggestion of Warren buffer, "There must be a fool in every market, if you look around for four weeks or you can't find someone who is the fool, then you are probably yourself!" ”。

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Unicorns have bubbles? absolutely! But not the valuation bubble