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It has been nearly two years since the valuations of private technology stocks peaked, throwing Silicon Valley’s start-ups into a curious netherworld.
In the absence of an active market in their shares, few have wanted to admit just how far valuations have fallen — and certainly not investors who came in late to the long private market boom, many of whom have not marked their holdings to anything approximating their current value.
As long as the companies involved do not raise new rounds of financing — and many don’t need to, thanks to the deluge of cash that preceded the market turn — then this state of affairs can carry on indefinitely.
Private companies that issue new stock options to their employees need to carry out formal valuations at regular intervals, shedding some light on the true state of affairs, but these internal procedures don’t force investors into a valuation reset.
For a generation of entrepreneurs that came of age during the late tech boom, meanwhile, the thought of accepting a sharp cut in valuation is anathema. If business is going well and a company is hitting all its growth targets, why should it be forced by the market’s whim into what looks like a concession of failure? The rebound in public tech stocks this year has also fed hopes that the slump may be temporary — though many of the high-growth companies that once enjoyed the headiest valuations have been left behind.
All of this makes the IPO next week of grocery delivery company Instacart an important psychological moment in Silicon Valley’s long adjustment to financial reality. Little known outside the US, Instacart has been something of a celebrity in start-up circles, rising to a valuation of $39bn in early 2021.
The jury is still out on whether companies like this will ever generate sustainable profits from sending people to do the grocery shopping for you. But Instacart has found a profitable seam to mine in selling advertising, suggesting that delivery apps that can amass a large audience will always be able to make money from their ability to influence the buying decisions of large numbers of consumers.
Depending how the share sale is received on Wall Street, the Instacart IPO could even prove to be something of a turning point in the start-up world’s slow-moving adjustment to financial reality.
Since growth stock valuations peaked in November 2021, “down rounds” by prominent start-ups — which involve a cut in valuation — have been few and far between. Payment companies Klarna and Stripe are among the very few to take this step.
With Instacart, Wall Street is about to be treated to a down-round IPO. At the midpoint of the range Instacart expects for its shares, anyone buying stock in the IPO will get it at a staggering 78 per cent discount to the price investors paid in the company’s last private funding round.
No company would willingly subject itself to that kind of heavily dilutive share sale unless it had to, and Instacart is no exception. It has a pressing need for $500mn to pay a tax bill linked to its employee stock compensation, precipitating the IPO.
Desperate times call for desperate measures. Rather than sell some of their stock in the IPO, as would normally be expected, Instacart’s two biggest venture capital backers — Sequoia Capital and D1, who own nearly 30 per cent of the company between them — have actually said they plan to buy more. Along with three other investors, they could buy about two-thirds of the $600mn worth of shares that are up for sale (Instacart is also raising $175mn through a separate private placement of shares to PepsiCo).
Besides potentially going a long way to underpinning demand in the IPO, the VC’s willingness to put up more cash at what is normally seen as the moment for an exit is a significant vote of confidence. How many other start-ups will be able to count on their early-stage backers for this kind of support when the moment of truth comes on Wall Street?
The headlines next week will no doubt make much of the collapse in Instacart’s valuation since 2021, and the pain for investors who came to the party late. But once Instacart gets through its baptism of fire on Wall Street, that moment will quickly be forgotten.
In another sign that tech investors are bowing to reality, SoftBank, owner of Arm, also accepted a lower valuation than it had hoped for in order to complete the chip design company’s IPO this week — though it has not had to undertake anything like the cut-price stock offering planned by Instacart.
The grocery delivery IPO will be seen as a low point for Silicon Valley’s start-ups. But it will mark an important step in the slow return to financial reality.