i am not I’m sure about you, but lately I’ve been hearing the same talk from friends and colleagues at startups. Most of the time it’s a question of: “Will my equity be worth something?” It is a version of
Let me start with the brutal truth: No one has a crystal ball to predict what the market will do or what will affect the stock of a private company. This may not be very comforting to hear, but I don’t believe it’s all doom and gloom. Another truth is that this is not the first market change, and it won’t be the last.
For me, the comforting thing to do is look at the data. I like to look at the past to better understand where we are going and history informs where we are now.
So, I looked at five market downturns in the past 20 years and analyzed how they affected private stocks, and most importantly, how long it took for the IPO market to reopen. After all, at the end of the day, we’re all looking for the same answer: When will my paper assets be liquid?
The crisis of 2002: the dot-com bubble
Since the late 90s, tech stocks have started to soar and trade at all-time highs. Does it sound familiar?
With interest rates down to 1.67 percent (compared to a rate of 0.25 over the past few years), capital was extremely cheap to borrow. That spurred investments in risky assets.
As the market began to crash, the decline was further reduced in 2002 by accounting scandals such as Enron in 2001, Arthur Andersen in 2002, and WorldCom in 2002.
Although there aren’t as many financial scandals today, the environment back then was similar to what we see now.
What was different?
The similarities between today’s market and the dot-com bubble end there.
The dot-com bubble was not an economic crisis per se, and was confined to financial markets. Furthermore, inflation was not part of the Molotov cocktail that is the driving force behind what is happening today.
What effect did it have on startups?
Startups have definitely found success. Private markets are not as transparent as public ones, so to get a better idea of what’s going on, I like to look at the iShares Expanded Tech-Software Sector ETF (Ticker IGV). This is an ETF that tracks technology companies – IGV is a basket of 119 software and interactive home entertainment and media stocks (Microsoft, Adobe, Salesforce, Oracle, etc.).
All of these failures have one thing in common: the IPO window finally reopened when the economy stabilized.
Although it is not a 1:1 representation of private markets, since it is an ETF based on public companies, we can estimate how multiples have been generated over this period because there is a correlation between the public and private markets.
Here’s what happened:
- Following the crisis, the stock market fell 55 percent before the first IPO.
- IGV’s EV/revenue multiple — a measure of how much every $1 of revenue translates into valuation — fell 57 percent.
- The IPO market has been closed for about 15 months.
- The first company to go public was Kalidus in October 2003, although it wasn’t the most successful exit.
- In June 2004, eight months later, Salesforce went public.
- A month later, Google made its official debut on July 29.
We are all familiar with the latter two stories.
2008 Crisis: The Housing Bubble Pops.
Now let’s look at 2008, the most recent recession. Credit originators, spurred by cheap credit and lax mortgage policies, have fueled rapid growth in subprime mortgages. That drove demand and speculation higher, creating a feedback loop for continued investor interest and initial incentives.
But as interest rates began to rise and liquidity dried up, overleveraged banks and funds began to rapidly unwind their portfolios. Values began to spiral and levels of empowerment began to dissipate.