Private vs Public Markets

I just turned 30 a few weeks ago and the majority of my adult life has been spent as an entrepreneur either founding or working at private and venture backed startups. As you all are familiar with I write a lot about the startup world and the mechanisms behind it that finance the growth of startups. But a recent infographic about the state of now public companies that were incubated and backed by VC dollars caught me by surprise and forced me to step back and spend sometime studying and trying to better understand the dynamics behind public markets and what they are telling us about the state of value creation in both private and public markets.

First, let's take a look at the infographic which came from Charlie Bilello and his blog on the Compound Capital Advisors site.

He shared this image on his twitter account a few weeks back and when I saw it I was a bit in awe as to how far some of the companies listed has drawn back from their all-time high stock price. All of the above companies were at one point the darlings of the Venture Capital world and were viewed as innovative startups pioneering new technology in their industry, so what is happening?

First off, competition is heating up. With the total amount of VC $s pouring into startups at record highs, there has never been a faster pace of innovation and new company creation in history, especially in the tech sector. Look at fintech, PayPal which once stood out as an industry leader and innovator in the field of finance technology now has more competition than ever from other traditional consumer fintech apps like Cash App, BNPL apps likes Klarna and Affirm, and cryptocurrency platforms like Coinbase and BlockFi. What is crazy is that PayPal, despite its stock being off by 37% has continued to grow from $10.84B in revenue in 2016 to $21.45B in 2020 which is a compound annual growth rate of 18% which is massive for a company of PayPals scale. So what is the issue?

Well since 2018, the number of fintech startups in the U.S. has nearly doubled from 5,600 to nearly 11,000 today. What has this resulted in? Fintech stock price multiples have pulled back. At the end of 2018, PayPal was valued at $110B on $15.5B in revenue which is a 7x multiple on their revenue. In the summer of 2021, PayPal had reached roughly $300 a share valuing the company at nearly $300B. They did roughly $22B in revenue the previous twelve months at that point meaning the stock price was trading at nearly a 14x multiple from their revenue, twice that of their multiple rate in 2018. Revenue increased roughly 33% and in the same time the revenue multiple to the valuation doubled. A mentor of mine, someone I consider to be one of the smarted people I know once told me, "Private markets always mirror public markets, often just 12-24 months later". Does this mean that valuation multiples in private markets are about to come back down in the next year or two?

I have also found myself following more and more public market experts on social media and in other channels to really try and understand the public markets sentiment towards private companies recently gone public. Below is a tweet that really stuck with me:

@Post-Market is a public market analyst and stock trader and more often than not her analysis on companies is spot on. Moiz Ali is the Founder of Native, and has founded several successful CPG companies through to exit. Honest Co did go public at a $2.7B valuation back in May, a 9x multiple from its 2020 revenue of $300M. Obviously that multiple has collapsed to roughly 2.33x as it stands today.

What I find more interesting is how they both view that valuation multiple collapse which is the disconnect that I am seeing more and more as I spend time with public market folks. Moiz mentions how brutal public markets are, which is a fair statement. But then @Post_Market calls private markets a facade...

And here is what has me so concerned about that initial chart above from Charlie Bilello's blog. There is clearly a disconnect that has emerged between private market investors and public market investors. One could say that revenue multiples are high in private markets due to the growth X factor, and that is perfectly fair, many venture backed startups are growing quite rapidly, but the issue with multiple valuation expansion and growth is that growth typically slows down as a % of the overall revenue of the company over time, if valuation multiples only continue to increase, especially when a company is private then there will be this massive gap at IPO for a lot of these companies where public markets won't tolerate the multiples that these companies are carrying.

Private markets and public markets are meant to work together to future, grow and support companies. Private markets are the feeders system, supporting and nurturing these small companies until they are big enough and have enough financial traction to be supported by the public. If the disconnect between private and public investors continues to grow,  there could be detrimental effects in the long run. Often times I see private market folks who say that we should keep companies private longer, perhaps indefinitely. That might solve not having to deal with public market analysts like @Post_Market, but this is excludes a massive % of our population from ever getting to share in the value creation of these startups as you need to be an accredited investor to invest in these privately held companies.

Now don't get me wrong, investing be it private or public should be looked at as a long term thing and over time all of the companies mentioned above still can be successful, grow and drive long-term shareholder value. The issue here becomes about the optics and mechanics of how this value gap has grown and continues to grow. One thing that will be telling of how this will play out is the recent Sequoia announcement of changing their fund structure to more of an ongoing/revolving structure in which they will keep and even potentially grow their positions in portfolio companies after they have gone public. With the same firm possibly seeding and holding stock long-term post IPO will the valuation multiples come down? It will be interesting to see how that plays out as Sequoia deploy capital under this new structure and what pressure that puts on other funds and valuations they attach to their investments.

I know I will be watching and it certainly will be interesting to see what happens over the next 12-24 months. As valuation multiples seem to be contracting in public markets, private markets have continued the trend of multiple expansion and eventually it all has to normalize. Have some thoughts on this topic? We always love hearing form the community so feel free to hit that reply button and let me know what you think, I keep trying to educate myself more every day on these topics so would love to hear how other view what is going on.

As Always, Talk Soon and Stay SaaSy ✌️