Private vs. public market investors: Who’s reaping the gains from the rise of unicorns?

This story was originally published in the 2Q issue of PitchBook’s Private Market PlayBook magazine.

A slow drama is currently playing out that’s radically altering the financial market landscape: the number of publicly listed companies in the US is steadily shrinking.

This trend has raised alarm bells across Wall Street and attracted attention from policymakers and capitalists alike. From our vantage point as a data and information provider on the private markets, we believe this is evidence of an ongoing transition into a new capital markets paradigm that includes a significantly more robust institutional private market.

To better understand this change we decided to look at a prominent collision point of this paradigm transition—IPOs and unicorns, which are defined as privately venture-funded companies with valuations of $1 billion or more. That unicorns exist, let alone flourish with 240 globally when this story went to print, is just one of the facts we submit in support of this shift. We’ll save the full manifesto on the new paradigm for a future edition of this magazine and, until then, share what we found as we pored over our data on unicorns and IPOs.

Not your 1990s’ IPOs

For ease and consistency of analysis, we focused on US-headquartered, venture-backed technology companies, and what we found confirmed some of our hypotheses, overturned others and opened our eyes to new ideas.

One trend that has been inarguable is venture-backed companies staying private for much longer than ever before. Since 2010, companies have been going public more than nine years after founding, compared to around five years in the mid to late ‘90s. That increase has meant these companies have gone public at a very different stage in their lifecycles—they’re much larger, they’re more sophisticated, they have a larger investor base and they’re often global in reach. It also means that there are fewer of them, as it’s a lot harder to stay in business and/or independent for nine years versus five.

There are several drivers behind the trend of staying private longer, and a few commonly cited causes are the increased cap on investors from the JOBS Act (from 500 to 2,000), new deep-pocketed entrants into the venture market (e.g., SoftBank Vision Fund, PE firms, mutual funds) willing to fund nine-figure investments into these companies, and SOX compliance expenses. Another interesting theory put forth by Dr. Jay Ritter (aka “Mr. IPO” from the University of Florida’s department of finance) is that private companies are moving so fast that a better route for them to reach their potential is to be acquired by an incumbent with scale, as opposed to building it themselves. We also believe many founders are intrigued by the relative freedom of the private markets, versus the scrutiny—and quarterly targets— demanded by public markets. As long as these factors stay in place, we don’t foresee the current IPO timeline changing.3

Which investors see the value?

Some of the world’s most highly valued public tech companies entered the public markets with quite modest valuations, at least by today’s standards. Microsoft, Amazon, Oracle and Cisco all debuted with market caps south of $1 billion. Of those, only Microsoft topped $500 million. This translated to relatively modest gains for their private market investors, compared to the massive value appreciation they have all experienced post-IPO. By comparison, the current crop of unicorns is creating massive gains for their private market investors.

When we first started compiling data for this article, we had a hypothesis that delayed IPOs meant a greater portion of the financial value that unicorns generate was being captured by private market investors instead of their public market counterparts. That turns out to be mostly the case but isn’t exactly the full truth. The reason being that the power law dynamic of venture investing economics carries through into the public markets post-IPO.

For this analysis, we started with 10 tech unicorns in the US that went public between 2009 and 2014 (for at least three years of trading data). We based their market caps at IPO to 100 and then charted their average monthly market caps up to May 9, 2018. We were surprised to see that only four of the 10 are currently valued above what they were at their debut. This means that, to date, six companies reached their peak valuations within the private markets and have only declined in value for any public market IPO investor.

If you had taken $1,000 and invested $100 into each of these companies at its IPO, you would have $1,679.88 today. Not a terrible return, but not great. The interesting reality is that 58% of that gain comes from just Facebook. Then 22% from Workday, 18% from Wayfair and 0.2% from Twitter. If you had instead invested that $1,000 in just Facebook, it would be worth $7,292 today. A sample size of 10 isn’t exactly exhaustive enough to draw solid conclusions from, but it certainly raises some questions about unicorn IPOs and to whom the gains accrue.

How today’s unicorns stack up

To get a better sense of private market value creation, we took a group of private tech unicorns in the US and divided their most recent private valuation by the number of years from founding to latest financing. This shows us how much value is being created per year private, while accounting for companies that have been private longer, and thus have had more time to accrue value.

We also selected a group of public tech companies and used their market caps on the day of IPO, then dividing that by the time from founding to IPO. Here are the results:

Uber is the only current unicorn that comes close to Facebook’s rate of value gain as a private company, possibly boding well for the ridehailing company’s planned listing next year (or beyond).

The remainder of the group shows an interesting trend: the companies having accrued private value the quickest tend to be younger companies, while the legacy tech titans accrued relatively little value while private. Amazon, Microsoft, Cisco and Oracle are barely visible at the bottom of the chart, yet all currently have market caps over $150 billion. As a comparison, the billions of dollars in value accruing these days to private investors is staggering. So, clearly the private market investors are profiting significantly more than public investors, right?

Wrong, kind of. Again, a mixed picture emerges where the top companies only accelerate in the public markets, accruing significantly more value to the public markets than the private ones. However, there is a larger number of companies that see marginal or even value destruction while in the public markets.

Clearly, Facebook is in a league of its own, but we also see the true explosion in value that the legacy tech titans have enjoyed since being public, dwarfing even Facebook’s value gains while private. We also see that some of the more recent entrants into the public arena have not fared so well. To be sure, it’s still far too early to make a definitive judgment on many of these businesses, but it does beg the question: Have some companies exhausted their potential value growth in the private markets?

Our original hypothesis was that the changing paradigm between the public and private markets means that private market investors are capturing a significantly larger chunk of venture-backed companies value creation than in the past, and potentially even more than public market investors. It turns out, like most things in life, it’s complicated. For many companies, that looks to be the case—causing us to be suspect of the ultimate performance of many of today’s unicorns, should they go public.

There are a select handful of unicorns, however, that will emerge from the private markets with the scale and momentum to only accelerate their growth post-IPO and bring with it majestic returns to their public market investors, as well.