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Silicon Valley Plays the Inflation Game

Katie Benner is a Bloomberg View columnist who writes about technology, innovation, and the cult and culture of Silicon Valley. She lives in San Francisco.
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Venture capitalists invested $48.3 billion in U.S. startups in 2014, making it the best year, in dollar terms, since 2000, when investors poured $105 billion into private companies, according to the National Venture Capital Association.

The most striking revelation from the NVCA report was that a quarter of the money went to late-stage investment rounds. Those were the deals that got all the attention: Uber raised so much cash that it’s worth $41 billion. With a $500 million investment, Airbnb is worth $10 billion. Snapchat turned down $3 billion from Facebook and is now valued at $10 billion. With $500 million in investment, Vice Media is worth more than the New York Times.

As my Bloomberg colleague Eric Newcomer points out, bigger investment checks were being written in 2014, meaning that the number of actual deals rose only about 4 percent, even as the total dollar figure jumped by 61 percent. The research company CB Insights said the number of late-stage tech companies to enter the billion-dollar valuation club increased 160 percent between 2013 and 2014.  (Keep in mind that those reported numbers are low, because they don’t account for late-stage venture investments made by corporations, hedge funds, mutual funds, private equity firms and sovereign wealth funds.)

That trend could be a cause for concern, however, if the companies aren't able to maintain their private market valuation when they finally go public.

The late-stage boom is being driven by a virtuous circle: Companies want to stay private longer because the valuations they can get from private market investors have been extremely high. To capture some of the value being created late-stage, traditional VC investors are carving out funds for those investments or raising dedicated funds to support the companies already in their portfolios. They continue to flood older private companies with money to keep up with the rapid increase in valuations in the private market.

This virtuous circle could be tested in 2015, as some of these highly valued late-stage companies finally go public. CB Insights notes that there are 588 companies in the IPO pipeline, of which 42 raised money at a valuation of around $1 billion each.

The idea that it’s better to stay private longer will be challenged if several companies go public at per-share prices that add up to less than their value in the private market. At the end of last year, for example, the app analytics firm New Relic and the big data company Hortonworks had IPOs at prices that were much lower than the private market rounds that valued them at about $1 billion. Although New Relic shares have risen and the company has a public market value of about $1.5 billion, Hortonworks is trading at just above $1 billion.

In a similar vein, Box is expected to price its IPO this week and investors will be watching for a big discrepancy between its public and private market valuations. Investors had shown muted enthusiasm for the shares in the past, given that the stocks of similar companies had fallen in 2014 and Box itself had a very high burn rate, meaning that it was spending money much faster than it could make it.

For now, bankers say that Hortonworks and possibly Box are anomalies. But if lower public market valuations develop into a trend, big late-stage funding rounds might be less common. This is especially true for hedge funds and mutual funds, whose investors expect more liquidity than those who invest in private equity or venture firms.

Would a cooling-down hurt the market for late-stage investing? Probably not. Venture firms are flush with capital and can often put money into existing portfolio companies or earlier-stage investments. But the private companies that have taken hundreds of millions in venture money would be hurt if the public markets soften and existing investors get squeamish. That’s why all eyes will be on Box, along with the next few companies with big private market valuations that choose to go public. 

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

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