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Silicon Valley has patented a new class of momentum stock in recent years. What makes companies in this group different is that they don’t rely on the usual Wall Street speculators to hype their prospects and pump up their share prices.
Instead, an ecosystem of opportunistic private investors with an eye for a quick return, along with the emergence of new and opaque secondary markets to trade the shares, has proved fertile ground for overheated speculation. Whether this can survive the fallout that is still spreading from last month’s botched Facebook IPO is another matter.
It was this investment market for late-stage private companies – essentially, those with the potential to go public soon – that did more than anything to fuel the latest consumer internet bubble. Centred on Facebook, it included Zynga and Groupon, both of which made it to the stock market last autumn, as well as companies that are still private like Twitter and Dropbox, the cloud storage company that was recently valued at $4bn.
If the demand from private market investors were there, so was the supply of entrepreneurs who were more than happy to bide their time before making the jump to the public markets. Mark Zuckerberg’s willingness to turn his back on the stock market far longer than the founders of other hot internet companies that came before has become a model for many other up-and-coming technocrats.
The hedge funds, mutual fund groups and others who had recently crowded into the business of investing in IPO candidates are now in retreat. That is the message from venture capitalists and investment bankers who are less prone to moving in and out of these markets as fashions change – though such generalisations should be handled with caution, since the investors who remain have every reason to boost their negotiating position with companies trying to raise money.
It isn’t hard to see why the pre-IPO investment craze looks a lot less exciting than it once did. Anyone who jumped into Facebook’s last big round of private financing – arranged early last year by Goldman Sachs and valuing the company at $50bn – has made a fair profit, though the low valuation of around $70bn hit earlier this month after Facebook went public yields nothing like the sort of windfall that many had anticipated.
For other companies, the picture can look a lot bleaker. At the peak of the pre-IPO craze early last year, for instance, social games company Zynga was valued in a private fundraising round at some $9bn – considerably more than the $4bn or so it is currently judged to be worth as a public company. Groupon, the daily deals company that spurned a $6bn takeover offer 18 months ago, was recently trading at a lower value than that on Wall Street – and only slightly above the level at which it raised money from private investors in early 2011.
If the late funding rounds lifted the valuations of these companies and stoked anticipation among eager stock market investors, a new group of private secondary markets, open only to experienced investors, added to the hype. It was these markets that put a peak price on Facebook earlier this year in the run-up to its IPO of $46 – considerably higher than the $31 or so that the shares now change hands for on the stock market.
For a time, the private momentum stock game looked like a winner for anyone who got in early. By the time the companies reached their IPOs, wide-eyed stock market investors were gagging for a piece of the action – and with only small floats of shares released to the public, the stocks enjoyed some early success.
If the public markets have wised up to this game – and if some of the speculative heat has left the pre-IPO business – then what does it mean for other companies that had been looking to ride the wave? After all, the ready availability of both capital and secondary market liquidity has helped companies remain private longer, while raising large amounts of cash and satisfying employees and early investors who want to sell some of their stock.
One answer came earlier this week from Facebook board member and early investor Peter Thiel in the form of a new $402m investment fund aimed at “growth” stage companies – the previously unfashionable segment of the venture capital market that sits between the earliest rounds of funding and the pre-IPO candidates. Mr Thiel wants to feed these companies the money to take bigger swings at new markets while digging in for a longer stay in the private world.
The Silicon Valley game of pumping up companies for quick IPO returns looks like it may be over – for now. But given how quickly venture capital fashions change, it is certain to return.
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