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Comment by theseatoms | Hacker News Reader

> Already we can see that the public markets can’t possibly absorb all the unicorns at their current prices.

Is there any evidence to back up this assertion? Seems to me that companies are voluntarily choosing to stay private, not that public equity markets can't handle the unicorns. (edit: Or is he saying that unicorns are overpriced because private investors value these companies more highly than public equity market participants would?)

All in all, business models that can't handle marginally higher financing costs probably weren't all that healthy to begin with. Rising rates should shake out the weaker hands, in a form of creative destruction.

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The math behind the public markets being able to absorb all the unicorns at their current valuations does seem a bit suspect:

http://fortune.com/2015/10/16/unicorns-ipo-market/

It's just unsubstantiated assumption, which is common when journalists cover things they have little knowledge about. If the public market can't 'absorb' it, then the prices will fall. A marketplace exists at these high pries because that's what people are willing to pay.

> If the public market can't 'absorb' it, then the prices will fall. A marketplace exists at these high pries because that's what people are willing to pay.

One structural difference between the private market and the public market is that in the public market, it's possible to short-sell a company's stock, and this is an important component in how the market settles on a price. In the private market, it's usually impossible to short-sell, so private prices may be biased upward relative to what they "would be" in a public market.

I'm not sure how big this effect is, though; just pointing out one reasonable possible source of difference between private and public pricing here.

> In the private market, it's usually impossible to short-sell

Not just that, but in the private markets, it's usually impossible to sell at all unless the company decides to let you (ie, unless it's beneficial to the company, or at least better for the company than the alternatives).

This fact alone strongly implies that prices will always inherently have an upward bias; it's actually quite difficult to conclude otherwise.

> This fact alone strongly implies that prices will always inherently have an upward bias; it's actually quite difficult to conclude otherwise.

Eventually it can get corrected, though, right? But as a sharp dislocation when fundamental reality percolates through as a wave of down valuations and shutterings, I suppose.

On this view, you'd want to short-sell the whole VC market if you could. This isn't possible directly, but maybe there's an indirect way? I'm reminded of how people sometimes place directional bets on "the hedge fund industry" as a whole by taking long or short positions on a basket of publicly traded companies that provide back-office and accounting services to a large percentage of hedge funds (e.g., NASDAQ:ADVS, NASDAQ:SSNC), and whose fortunes therefore rise and fall with the hedge fund industry's -- maybe one could construct some indirect play like that for VCs?

Maybe you could find a SF regional REIT to short? Though that's a hop, skip, and a jump removed from your investment thesis.

> This fact alone strongly implies that prices will always inherently have an upward bias

Can you expand on this? Do you mean the incentive is to push for a constantly higher price because you have to hold on to it?

A decline in stock price of a publicly traded company is an everyday trivial occurrence.

A decline in stock price of a private company implies a down round, which triggers all sorts of ratchets and provisions, usually binds the company to all sorts of new limiting ratchets and provisions, and is generally perceived as a severely negative event for investors, management and employees.

> Can you expand on this? Do you mean the incentive is to push for a constantly higher price because you have to hold on to it?

Thinking at a macroscopic level, in an open market, the price of a security isn't just "what people are willing to pay for it" (contra great-GP), but rather the balance of what people are willing to sell it for and what people are willing to buy it for. When you prevent one half of that price-discovering mechanism from occurring (selling), you can expect an imbalance -- at least for the market as a whole... for specific, individual companies this may be a second-order effect.

Thanks. That makes sense.

  absorb all the unicorns at their current prices

As to the second point, the "high prices" are in the private market and yes "that's what people (in private market) are willing to pay".

But that doesn't imply it would be the same in public market.

"that's what people (in private market) are willing to pay"

And on top of that, investors paying those amounts are also able to influence their investment in ways they couldn't do as easily in public markets, whether it's buying a board seat, setting up multipliers, dilution protections and last in / first out agreements (and I'm sure others that I'm not even aware of).

The EMH says it shouldn't matter too much. The transition from private to public adds more liquidity for traders, but in accordance to the EMH it should work both ways (50% chance of buying or selling). Those who wanted to buy but couldn't will do so now that the shares are public, and some will sell. There should be no expected edge shorting companies that go public, after taking into account borrowing costs and other factors. The evidence suggests such a strategy would probably break-even, in accordance with the EMH.

https://qph.is.quoracdn.net/main-qimg-ef1c7da1ddf19c2c7c7d90...

Yes but how efficient is the market for private equity? It seems like all kinds of information in the private equity market is potentially hidden from bidders, including past prices.

A VC fund averages slightly better than the market, suggesting possible inefficiencies

But VC funds take on significantly more risk than a broad market, long-only index fund. So VCs need to yield a proportionately higher return, if we're comparing apples to apples.

https://en.wikipedia.org/wiki/Sharpe_ratio

Liquidity absolutely has a massive impact on prices. Less liquidity = less price discovery = greater volatility.

The author is a VC, not a journalist.

From the authors linkedin:

    Managing Director and Co-Founder
    Garage Technology Ventures

    Harvard University
    AB, History of Science

    Stanford University Graduate School of Business
    MBA, Finance, Economics, Public Management

He seem's to have a sufficient background to support such an analysis.

https://www.linkedin.com/in/billreichert

Then I'm guessing it's more a matter of his readership's level of finance knowledge. Seems like he's dumbing it down for TC.

By why are they willing to pay these high prices now vs a few years ago? What has changed in the economy or investing climate and is it sustainable?

Totally inexperienced opinion here:

We're in an advertising bubble. Remember the ridiculousness surrounding the "Yo" app? People running around in circles about how it can be a great way to increase brand awareness due to the simplicity of it all? How it can connect with so many different apps? Yeah ... it's panned out exactly like its detractors predicted: sharp declines in downloads, hype is dead, and people have moved on to the next social app fad.

Another factor I'm noticing is international money. Uber didn't start approaching ridiculous valuation levels until Chinese investors started getting on the train.

You cited one defunct app that never went anywhere as evidence of an advertising bubble?

While I definitely think display and video CPMs are overvalued compared to what they drive (which attribution solutions will help correct), there is strong measurable value that Google, FB and Bing are delivering from a post-click measurement standpoint. But let's just conveniently ignore these companies that drive billions in revenue for their customers.

> You cited one defunct app that never went anywhere as evidence of an advertising bubble?

That they were able to raise $1.5M in seed funding is evidence of a bubble.

https://www.crunchbase.com/organization/yo

It is not. You are citing a single example of one company that got seed funding from a few investors who are not top tier players.

Your point provides zero evidence to a bubble in the advertising industry, which is a behemoth filled with established players driving measurable value for their customers.

You can't get good returns in the bond market with interest rates this low, so there's a lot of money out there looking for better returns even if it means higher risk.

these companies (snapchat, uber, dropbox, pinterest, etc) are rapidly growing, that's a major why

Are any of these profitable (except maybe, possibly Uber)?

The problem is even if they could be profitable, they choose to invest all the money they can in growing rather than making a profit. So it's hard to know.

The math is a bit tricky, but it gets even murkier when you look at all the extra rights/ratchets/etc that series D gets over C over B over A over common.

As such if last private valuation is $1B, common shareholders (and probably series A and B) as well will be pushing for any IPO valuation well in excess of $1B so that C and D don't get all the money and A, B and common are not underwater.

All that being said, C & D have powerful reps on on the board who often don't vote with the interests of the common holders despite their fiduciary duty to do so. The NY Times had and article on this conflict of interest problem a few weeks back. I will try to find link and repost.

Edit: Link to article on board members and inherent conflicts between different share classes.

http://www.nytimes.com/2015/12/27/technology/when-a-unicorn-...

How does a company stay private if it's underpaying its employees, and their only chance of breaking even is the IPO? Or alternatively, why would employees choose to stay after the company decides not to IPO?

I worked at a company like that in the late '90s. For years we were perennially "six months away" from IPO until the bubble burst. When people realized the IPO was never actually going to happen there were some pretty large salary adjustments.

Eventually (after I left) they were bought by a competitor.

the math might be suspect, and it might just be straight assumption by the writer.. but it doesnt mean it cant be true - or isnt true

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