After watching Lucy pull the football from Charlie Brown’s foot at the last possible moment time and time again, we have learned our lesson and are therefore hesitant to believe that 2024 will be the year of the IPO market’s return. It may or may not happen, but we’re not betting on it.
Alternative sources of liquidity are therefore top of mind — there’s a towering pile of private companies in need of an exit, or a bailout. Recent research from Cowboy Ventures’ Aileen Lee underscores how quickly illiquid wealth was accumulated in the private markets in the last decade, and how rare exits have become for unicorns and other richly valued startups.
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Lee found that the number of unicorns in the U.S. had increased 14 times over the past year, reaching 532 in 2013 from just 39 in 2013. However, the rate at which unicorns went public moved in the opposite direction — only 7% of unicorns today have found an exit, down from 66% of the initial cohort. Note that TechCrunch, like many publications, focuses only on private unicorns while Cowboy Ventures is also counting those that have gone public.
This puts startups in a difficult spot. But the good news is that some untraveled and overgrown exit paths have a chance of opening up this year. The bad news is that those avenues may offer prices far less than what many startups are willing to accept. Call it painful price discovery.
Let’s talk private equity, startups, and their possible marriage this year.
Why do bad tidings make for good news sometimes?
In theory, stumbling unicorns do not make for good exit candidates. Why would a company with low chances of getting more VC investment become an M&A target? Well, it’s because many private companies had to prioritize profitability and runway over growth when the wider market decided tech companies weren’t actually worth as much as they used to be.
After 2021’s venture boom imploded like an initial coin offering from 2017, startups were told that they needed to pull back spending and get close to cash flow breakeven to survive, and many made great strides on this front. However, a slow-growing, cash-generating business is not what venture capitalists like to invest in. They prefer fast-growing and efficient companies, which means there are many startups out there that are not ready to do an IPO but are also not going to die.
For such companies, some of which could be unicorns, private equity may be the only viable path to an exit. What do you do if you can’t raise capital and your IPO dreams don’t pass the smell test? Sell to the vultures, perhaps.
Old playbooks
Startups’ return to the profitability path may help them look to a new horizon: private equity. These so-called vulture funds aren’t typically interested in businesses that don’t have significant cash flow, since their playbook of attaching debt to the companies they buy wouldn’t work. Neither would private equity firms be willing to pay double-digit multiples solely based on the rate of revenue growth. This dissonance meant that most startups were out of the private equity circle of interest during the hype days of 2021 and earlier. But things have changed since.
Indeed, we learned from PitchBook’s sources that private equity funds are looking to snatch up startups in need of capital, and there seem to be quite a few of those lying around today: Many startups that raised at the apex of the bubble are now struggling to get more money from their existing investors, let alone new ones.
However, this feels very much like bargain-hunting. “PE buyers chasing startups now are very price sensitive, demanding relatively low multiples,” PitchBook noted. Forget double-digit multiples; we could be talking multiples as low as 1x or 2x.
Even so, not all takers will be in poor shape; they might just be more capital-intensive than the average startup. For instance, climate tech startups could be good candidates for PE, Sifted reported.
Selling to a PE firm is probably not what venture capitalists were hoping for when they placed their bets. But unlike more aggressive PE takeovers, such an exit strategy could end up saving companies and jobs. Consolidation is still on the cards, of course, but buyers will likely be more growth-oriented than looking to cut costs.
It should be enough to keep us curious, if not entertained.
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