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WeWork stands in the Williamsburg neighbourhood in Brooklyn in New York City. Image Credit: AFP

New York: This was supposed to be the year when America’s biggest start-ups would finally make their triumphant debut on the stock market.

Billionaire Silicon Valley investors, sneaker-clad founders and button-down bankers all expected enormous stock sales to turn companies like Uber, Lyft and WeWork into a new generation of corporate giants. It hasn’t quite turned out that way.

Last week, WeWork postponed its planned initial public offering. Uber and Lyft sold shares earlier this year only to see their prices collapse. Investors took a look and backed away, seeing overpriced companies with no prospect of making money any time soon, in some cases led by untested executives.

The rejection threatens Silicon Valley’s favoured approach to building companies. The formula relies on gobs of money from venture capitalists to paper over losses with the expectation that Wall Street investors will eventually buy shares and make everybody rich. If mutual funds and pension funds are no longer wiling to buy once the companies go public, fledgling companies are unlikely to find funding in the first place.

“When the IPO market is hurting, it has a domino effect on valuations and venture capital deals,” said Steven Kaplan, a professor of finance and entrepreneurship at the University of Chicago. If it persists, that could make it harder for start-ups to raise money, he said.

A fiasco from the start

Much of the recent concern has been directed at WeWork, a shared office space company based in New York. As it began to approach stock market investors, the company revealed losses of $1.37 billion in the first-half of 2019. Investors also questioned financial dealings of WeWork’s chief executive, Adam Neumann, and the company’s accounting.

Neumann stepped down under pressure from directors and investors. It is now uncertain when the company will return to the market.

A thumbs down

Uber, by comparison, cut its expected price in May. Even so, its shares have fallen about 30 per cent as the company’s financial losses have deepened. In the three months through June, the company said it lost more than $5 billion and reported its slowest revenue growth in its history. (Shares of its rival Lyft have fallen 40 per cent since the company’s debut in March.)

Other companies have delayed their plans. Airbnb, the vacation-rental business, said last week that it did not plan to go public until 2020, later than expected.

Some standouts

Not every prominent offering has floundered. Many smaller listings have soared. Among the larger ones is the online pinboard company Pinterest. Its shares are up 44 per cent since it went public in April.

But Pinterest priced its IPO conservatively, told investors that it was close to profitability, and has narrowed its losses in the months since it became publicly traded. And the company is increasing revenue — which comes from advertising — fast.

“Investors are buying the future, so help them pencil out the future,” said Rett Wallace, whose firm, Triton Research, analyses tech companies that are going public. “You can do that with Pinterest. You can’t do that with WeWork. You can’t do that with Uber or Lyft either.”

All in the offer price

In many ways, the current standoff between Wall Street and these giant start-ups comes down to a simple issue: price. Because of expectations set by venture capitalists, and given the risks they face, the companies simply asked for too much.

Uber, which private investors valued at roughly $72 billion before its IPO, is now worth about $54 billion in the public market. Lyft, once said to be worth more than $15 billion as a private company, now has a market capitalisation of roughly $12 billion.

WeWork was last valued at $47 billion in the “late stage” market of mature private companies. In the run-up to its failed attempt to list shares, executives and bankers had discussed slashing the valuation to $15 billion — but were still unable to gin up enough interest.

Greed

The tepid response to these companies stands in stark contrast to the dot-com bubble of 20 years ago, when shares of start-ups with little revenue or prospects for profit — like Webvan and Theglobe.com — were greedily bid up in their market debuts.

“Everyone feared this would be another bubble like in 1999 and 2000,” said Kathleen Smith, principal at Renaissance Capital, which provides research on IPOs and manages exchange-traded funds that track their performance. “But there is a lot more sanity in the reaction of investors to these deals.”

Less tolerance

Now, the verdict from the stock market is that it’s the private investment binge that has gone too far. With a flood of cash, private investors backing the hottest start-ups have inflated their valuations to a point that public investors cannot tolerate.

“Things have gone a bit nutty,” said Fred Wilson, a partner at Union Square Ventures, a New York-based tech investor. This moment could be a turning point in what public market investors will accept from highly valued, money-losing start-ups, he said.

“I think that’s very important for private markets,” Wilson said.

The recent troubles may stem from the long incubation period the largest start-ups have had. Flush with funding from venture capital and other private investors, the companies have not been forced to go to the public markets to secure financing like they might have in the past.

It was not always this way. Traditionally, the IPO market has allowed investors to put their money into relatively small, higher-risk firms with enough potential for fast growth that stock buyers are willing to overlook their often numerous warts.

Amazon.com sold shares to the public just three years after its founding in 1994, raising just $62 million in a deal that valued the company at more than $400 million. The company has a value of more than $800 billion now.

Google was a much bigger, and older, company when it went public in 2004, valued at roughly $23 billion, a deal that was enormous by the standards of the time. But it was also incredibly profitable — with an annual profit of more than $400 million the year it went public — and still fast growing.

That last part is particularly important, says Jeff James, who manages more than $1.7 billion for clients at Driehaus Capital Management, a Chicago-based investment adviser, who bought shares of Pinterest in its IPO.

“Growing above expectations, that really cures valuation and other faults,” he said.