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What market volatility means for ‘pre-IPO’ startups

October 16, 2014, 7:08 PM UTC
Finance
contract armin harris
Kyle Bean for Fortune

So, is this it? Is this the market correction that many investors have been publicly expecting, while privately hoping things are really different this time? Or is it just short-term volatility related to knee-jerk Ebola fears and confusion over falling oil prices.

Obviously it’s too early to draw conclusions, except for this: What we’ve seen over the past few days has put a major chill in the IPO pipeline. Not quite cold enough to block it completely, but certainly the opening has narrowed.

Leslie Pfrang, a principal with IPO advisory Class V Group, says that she can’t imagine too many new issuers moving forward if the volatility persists, save for large outliers (i.e., sub-Alibabas). Too little stability, too many valuation worries and widened IPO discounts. Plus, when markets bottom, investors tend to sell down positions in smaller holdings (i.e., recent IPO issuers) in order to raise cash for buttressing core positions in larger companies.

“If the market is too volatile, you can’t just project the standard 15% IPO discount going forward, because banks and investors are going to be nervous about bringing it to market or buying it,” she says. “What’s important to keep an eye on, though, is that the companies that keep preparing and are ready to go first when the market reopens are able to benefit the most. Maybe they don’t get the best valuation, but they are able to access the market multiple times for capital and it gives new investors more liquidity opportunities.”

Another open question is what a major correction would do to the legion of pre-IPO “unicorns,” which have raised huge equity rounds at high valuations.

Namely, if they need to delay IPOs and haven’t properly managed burn rates, who is going to step up for the next round (even if it comes with a valuation haircut)? When public SaaS valuations tanked earlier this year, the mutual/hedge fund community stopped back such companies on a dime, only returning once the public markets stabilized.

If this is a broader-based downturn, I could see them walking away from all sorts of sectors. And given that most of these companies already worked through the traditional later-stage VC class, it would seem that an unexpected M&A rush could be on the horizon.

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