Tech IPO Market Struggles Continue into 2023

2021 was a remarkable year for tech IPOs, with electric car maker Rivian, restaurant software company Toast, cloud software vendors GitLab and HashiCorp, and stock-trading app Robinhood all making their debuts. However, 2022 has been a complete letdown in comparison.

This year, Intel's spinoff of Mobileye was the only noteworthy tech offering in the United States. Mobileye is a 23-year-old firm that produces technology for autonomous vehicles and was publicly traded until it was bought in 2017. The company raised nearly $1 billion, and no other U.S. tech IPO was able to bring in more than $100 million, according to FactSet.

In 2021, the U.S. saw a surge in tech IPOs that raised $1 billion or more. This number does not include the direct listings of Roblox, Coinbase, and Squarespace, which were already well-funded and did not require additional capital.

When the calendar changed, investors shifted their focus from risky investments with potential for growth to businesses with strong financials that could withstand an economic downturn and higher interest rates. Companies preparing for an IPO had to adjust their plans after witnessing public market peers drop by 50%, 60%, and in some cases, more than 90% from the previous year's peak.

Ernst & Young's IPO report, released in mid-December, revealed that the total proceeds from IPO deals in 2022 had dropped drastically, from $155.8 billion to $8.6 billion - a 94% decrease. At the time of the report's publication, the fourth quarter was projected to be the weakest of the year.

The Nasdaq Composite is on track for its most significant annual decline since 2008 and its first consecutive years of underperforming the S&P 500 since 2006-2007, leaving tech investors searching for indications of a turnaround.

David Trainer, CEO of stock research firm New Constructs, believes that investors should focus on the fundamentals of emerging tech companies rather than their potential promises. He believes that this is the best way to accurately value these companies.

In 2020 and 2021, as tech IPOs were booming, Trainer was sounding the alarm, releasing in-depth reports on software, e-commerce, and tech-related companies that were taking their high private market valuations to the public markets. Trainer's predictions seemed overly pessimistic when the market was soaring, but many of his selections appear to have been accurate today, with Robinhood, Rivian, and Sweetgreen each down at least 85% from their peaks in the previous year.

According to Trainer, the IPO market will remain stagnant until investors begin to prioritize capital allocation over other factors. He believes that when investors focus on the fundamentals, the markets will be able to fulfill their purpose of allocating capital in an intelligent manner.

Lynn Martin, the president of the New York Stock Exchange, expressed her optimism for 2023 during an interview with CNBC's "Squawk on the Street" last week. She noted that the backlog of activity is at an all-time high and that it will only increase once the volatility in the market begins to subside.

Organizations in the pipeline face a complex issue that goes beyond just dealing with a bear market and instability. They must also recognize that the appraisals they received from private financiers do not mirror the alteration in public market opinion.

In the past few years, businesses have been able to secure funding due to the long-term success of the stock market, as well as the historically low interest rates. Additionally, the tech industry has been a major factor in the economy, with the initial public offering of Facebook in 2012 and the wealth created by companies such as Uber, Airbnb, Twilio, and Snowflake, which has been reinvested into the tech sector.

Venture capital firms have been raising increasingly larger funds, which has caused competition with a new group of hedge funds and private equity firms that are investing a great deal of money into tech. This has caused many companies to remain private for a longer period of time than they would have otherwise.

There was an abundance of money, but it was not managed responsibly.

In 2021, the National Venture Capital Association reported that venture capital firms raised more than $131 billion, surpassing the $100 billion mark for the first time and continuing the trend of more than $80 billion raised for the second consecutive year. Additionally, the average post-money valuation for VC deals across all stages increased to $360 million from approximately $200 million in the previous year.

The high valuations of the past are now a thing of the past, and any companies that raised money during that time will need to confront the current market conditions before they can go public.

Certain late-stage startups that are highly valued have already experienced some losses, although they may not be as severe as expected.

In July, Stripe reportedly reduced its internal valuation by 28%, from $95 billion to $74 billion, according to people familiar with the matter, as reported by the Wall Street Journal. The Financial Times reported that Checkout.com cut its valuation this month to $11 billion from $40 billion. The Information reported that Instacart has experienced a decrease in its valuation three times, from $39 billion to $24 billion in May, then to $15 billion in July, and finally to $13 billion in October.

Klarna, a company that specializes in providing buy now, pay later technology, experienced a significant decrease in value compared to other well-known startups. This year, the Stockholm-based firm raised funds at a valuation of $6.7 billion, which is a massive 85% decrease from its prior valuation of $46 billion.

Don Butler, managing director at Thomvest Ventures, noted that the effects of excessive alcohol consumption in 2021 were still being felt.

According to Butler, the IPO market is not likely to improve significantly in 2023. The Federal Reserve's continuous rate increases could potentially lead to an economic downturn, and there is no indication that investors are willing to take on any risks.

According to Butler, businesses are experiencing a decrease in both business-to-business and consumer demand, which will likely make the upcoming year difficult.

According to Butler, Silicon Valley must make changes to the way it operates in order to see a resurgence in the IPO market. This includes becoming more efficient with capital, demonstrating a clear path to profitability, and moderating hiring expectations. Additionally, organizations must make structural changes to their operations.

In recent years, startups have invested heavily in human resources to manage the surge in personnel and the competitive recruitment across the sector. However, during a hiring freeze, there is much less need for those positions, and Layoffs.fyi reports that the market has experienced 150,000 job losses in 2022.

Butler predicted that it would take a few more quarters for the "cultural reset" to take place, and he expressed his doubts about the IPO market.

Databricks is a high-priced private company that has managed to keep its value. Their software assists customers in organizing and refining data so that personnel can analyze and utilize it.

In August 2021, Databricks raised $1.6 billion at a $38 billion valuation, which was close to the market's highest point. By mid-2021, the company was projected to make $1 billion in annual revenue, showing a 75% increase from the previous year. It was one of the most anticipated IPO candidates of 2021.

Ali Ghodsi, CEO of Databricks, is not currently discussing the possibility of an Initial Public Offering (IPO). Instead, he is not expressing any worries about the financial standing of his company. In fact, he believes that being a private company is beneficial for them.

According to Ghodsi, if a company is public, the primary focus should be on cash flow and what can be done to increase it. He understands that this is what the markets require, but since his company is not public, they do not have to abide by this.

According to Ghodsi, Databricks has a substantial amount of money and would be able to remain financially secure even in a difficult economic climate such as the dot-com crash of 2000 without needing to raise additional funds.

Databricks has been able to avoid layoffs and their CEO, Ghodsi, has stated that they intend to keep hiring in order to take advantage of the abundance of available talent.

According to Ghodsi, the company is in a special situation due to its strong financial resources and private status. He added that they plan to take an unconventional approach when it comes to investments.

Databricks may be a desirable option for an initial public offering in the future, however, the valuation is still a lingering issue.

Since reaching its peak in November 2021, Snowflake, the public market counterpart to Databricks, has seen its value drop by almost two-thirds. When it went public in 2020, Snowflake set a record for the largest software company IPO in the United States, raising a total of nearly $3.9 billion.

Snowflake's success has been impressive. In the most recent quarter, revenue increased by 67%, surpassing expectations. Adjusted profit was also higher than anticipated, and the company reported generating $65 million in free cash flow.

Despite this, the stock has seen a decrease of almost 20% in the last three months.

Frank Slootman, CEO of Snowflake, expressed to CNBC's Jim Cramer that the market was feeling a bit anxious following the earnings report on November 30th. He acknowledged that people tend to react strongly, but he also noted that they must take things one day and one quarter at a time.

Take a look at the CEO of Snowflake discussing the company's outlook for the future. He provides insight into the guidance they have set for themselves.