In the run-up to its initial public offering, cloud computing company Nutanix scrambled to avoid a situation that has increasingly marred technology IPOs: a price that’s below the most recent private funding round.
After bumping up its price Wednesday to $13 to $15 per share, Nutanix will be valued at $1.9 billion at the mid-point of that range, just shy of the $2 billion valuation it received in a 2014 private funding round. The final price will be set later Thursday in advance of trading on Friday.
Once a rarity, public offerings at a price below the private market valuation have become common, especially for venture-backed companies worth $1 billion or more – the so-called unicorns. Such low-priced IPOs have been often been followed by lackluster public market performance, and can lead to problems with employee morale, recruitment and retention, dealmakers say.
Of the 32 technology companies that went public with downrounds since the start of 2012, 53% are trading below their IPO price, based on an analysis of data provided by venture capital database PitchBook Inc.
Shares of payments company Square, storage firm Box, big data company Hortonworks and solar energy operator Sunrun, all of which had their valuations slashed, are trading between $5 and $8 below their private market valuation.
“That high valuation can really come back to haunt you,” said Nate Gallon, a partner with Hogan Lovells law firm.
In the most difficult situations, companies that IPO at a lower valuation can trigger an anti-dilution provision called a ratchet, which rewards later investors with more shares at the expense of employees and early investors.
Nutanix has two ratchets that could be triggered by a low valuation, though the company appears to have avoided that situation.
Nutanix declined to comment for this story.
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A study by law firm Fenwick & West found that, in 2014, 4% of IPOs had a ratchet that was triggered. In 2015, that jumped to 50% of deals. The Honest Company, Simplivity and DocuSign are among the other unicorns that are approaching IPO and also have ratchets, according to PitchBook.
“It’s safe to say that almost every (investor) now asks for a ratchet,” said Dave Peinsipp, a partner at Cooley law firm.
Many of those requests come from mutual funds, hedge funds and sovereign wealth funds, which in recent years have joined more late-stage rounds.
“If the company turns around and does a down IPO, those late investors don’t want to be left holding the bag,” Gallon said.
Some investors argue that, after the IPO, downrounds and ratchets are a distant memory. However, they can also signal deeper problems in the company.
“I don’t think you accept ratchets if you have a choice,” said Hemant Taneja, managing director at General Catalyst Partners. “What does it say about a management team that overshot its valuation? Some bad decisions made somewhere.”
For its Series B investment round, Nutanix chose Khosla Ventures because the firm offered a valuation of more than $100 million, said Mohit Aron, co-founder of Nutanix who left the company in 2013 to start a new startup, Cohesity. The firm obtained a $1 billion valuation with its Series D, which included a ratchet.
Compare that to software company Atlassian (TEAM), whose valuation jumped 32% at its December debut and whose stock is up 44%. The profitable company did not raise any venture capital to fund its business operations, dismissing investors who came knocking with offers of bigger valuations.
“What would the point be? It felt that it became this vanity metric,” said Jay Simons, Atlassian’s president.
