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When Reddit lists on the New York Stock Exchange next week, the social media platform is expected to carry a valuation of up to $6.4bn — well down on the $10bn it was worth in 2021. It will be the first high-profile tech start-up to list since Instacart, which was valued at $10bn in its initial public offering in September, just a quarter of the eye-watering valuation placed on it by investors in 2021.
Despite the combined nearly $35bn write-off of supposed shareholder value, these “down round” IPOs are not being met with derision in Silicon Valley. Instead, they are a signal that rationality is slowly returning to venture capital.
Down round IPOs “are not only going to become common, they will become the standard for the class of 2021”, says Venky Ganesan, a partner at Menlo Ventures. He is referring to a group of late-stage companies whose valuations soared that year as investors, punch drunk on low interest rates, poured in astronomical sums. US venture investment in 2021 was a record $345bn, more than double the previous year.
Now start-ups are running out of cash and venture capital funds need to return some money to their investors. “I am encouraging all of our companies who have the financials to support going public to go public,” Ganesan adds. “Down is the new up.”
It is a sentiment that has been rippling across Silicon Valley with increasing confidence in recent weeks as technology stocks rally, partly on the booming prospects of artificial intelligence. “People who were hiding in their caves are now wandering outside and feeling good and that is palpable,” a co-founder of a large venture firm told me.
Successful new investments in AI could offset a multitude of misjudgments in the recent past. And there is a growing consensus that it is finally time for founders to swallow their pride, accept a massive haircut to valuation and help establish a new floor for their stock to start growing again, helping to encourage all the companies coming up behind them to do the same.
Not everyone will fall into line. Stripe co-founder John Collinson told the Financial Times this week that he was “not in a rush” for an IPO of the $65bn payments group. But a few more solid companies coming to market at reset prices may help destigmatise the long-held psychological opposition to down-round financing that has become baked into Silicon Valley’s culture. Reddit’s investors have maybe had to recognise the reality that it is not a $10bn company at IPO but if the company does well, the lower valuation might become a floor for its stock price.
Still, when listings start happening in force, there will be some seriously painful consequences for later-stage investors who fuelled the 2021 start-up bubble. There are hundreds of companies that were funded in a low interest rate environment that should have been shut down or sold, but have managed to only delay the inevitable reckoning. A valuation cut might not be the worst outcome for many.
The looming crunch also highlights the cost of the herd mentality in the venture capital industry, which has become comfortably used to mostly moving en masse and in the same direction. The rush erodes discipline.
In 2021, deep-pocketed investment funds competed for ways into overpriced fledgling companies. In many cases, they signed away key protections, including those that allowed them to veto an IPO below a certain price.
Unlike a sale of a company or a liquidation, a stock market listing converts all preferred stock held by a business’s venture investors to the same common stock held by employees and management, extinguishing the various rights secured by backers over rounds of raising private funds. The drop in valuation combined with the lack of protections means late-stage investors have little recourse to prevent decisions likely to result in punishing losses.
Sequoia Capital, which invested $300mn in Instacart over its lifetime as a private company, made a paper gain of more than $1bn when it listed — but at one point that investment was worth as much as $5bn. Firms including Sequoia, T Rowe Price, Fidelity and Andreessen Horowitz that invested a combined $265mn in Instacart in 2021 saw that investment collapse by 75 per cent.
“It is becoming increasingly clear that whatever was underwritten is no longer the case,” said one venture capitalist at a firm that controls billions of dollars. If Silicon Valley is moving through the stages of grief from denial and anger to acceptance, that might be a healthy thing in the long-run.
