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Why tech IPOs may not be as hot as they look

By Kevin Kelleher , written on December 24, 2014

From The News Desk

Five years after the Great Recession ended and 15 years after the dot-com boom went bust, the IPO market for tech companies looks to be roaring back. But although it can be said that this was the busiest year for US IPOs since 2000, a closer look at the numbers shows that, in some ways, 2014 was something of a letdown.

According to Renaissance Capital, 273 companies across all industries listed on US markets this year, raising a total of $85 billion. However, 100 of these were biotech startups tapping into investor demand for new drug therapies. And six of the 10 largest IPOs were in the financial sector.

Nonetheless, it was a busy year for technology IPOs: 55 companies in the technology sector went public, Renaissance said, raising a total of $32 billion. That compares with 45 tech companies that went public in 2013, raising $8 billion.

But as anybody who paid even the slightest attention to the IPO market knows, the big event in tech IPOs was Alibaba's offering, the largest US IPO ever. The Chinese e-commerce giant listed in September, raising $22 billion, or more than two thirds the total amount raised by all companies within the sector.

Factor out Alibaba, and you have 54 tech companies going public, raising just $10.5 billion dollars. As important as the Alibaba IPO was for technology IPOs, it also distorts a little the trends that can be extracted from aggregate numbers.

What's more, the aftermarket performance of tech IPOs was decent in 2014, but not as strong as last year. While it's true that December listings such as Lending Club, Hortonworks, and New Relic have surged above their offering prices, the average aftermarket performance for tech IPOs was a return of 14%, in line with the industry average but down markedly from a return of 43% percent in 2013.

So while the pipeline for technology IPOs can be said to have been robust this year, and the the general appetite among investors to be healthy, 2014 was not quite the blockbuster year in IPOs that it may seem at first blush, and certainly nothing like the overheating engine of the IPO market in the late 1990s.

In fact, the biggest story concerning the tech IPO market was what didn't happen there. Or rather, what happened outside of it, and how far and many private tech companies were willing to go to to avoid the scrutiny and costs involved with listing their stocks in the public market.

Many companies that were expected to go public one year ago remain in the pipeline today. A look back at the biggest names that were expected to debut on public markets in 2014 included some that made it – Alibaba, Lending Club, King Digital, GoPro – and even more that are still private: Airbnb, Dropbox, Square, Jawbone, Evernote, Box, Pinterest, Palantir, Uber, Gilt, Square, and so on.

All of those companies appear on CB Insights 2015 IPO pipeline report, and it may well be that, if some of them have their way, they'll be on the 2016 pipeline report as well. As CB Insights noted, of the 590 companies in their 2014 report, only 67 exited via IPOs or M&A, while 192 raised additional private financing – of which there was plenty to be found.

Megarounds of private financing took off in 2014, even if IPOs didn't. In 2012, according to CB Insights, ten companies had financing rounds of $100 million or more. In 2013, the number doubled. This year, 50 companies saw $100 million-plus rounds. Yet there were fewer than 10 tech companies that raised that much in the public markets.

Companies often cited the volatility of the general stock market for delaying their IPOs. But this doesn't square well with reality. Tech companies that listed this year and delivered solid financial results saw their stock prices rise. And the Nasdaq Composite rose 14% this year, with far more up weeks than down ones. Any losses from corrections in 2014 were usually erased in a matter of weeks.

The health of the public stock market is important to private investing – if the mood is unhappy on Wall Street then private investments slow as well. But over the past few years it's become easier for institutional investors to participate in private rounds, without having to jockey for allotments in oversubscribed offerings. And many companies would prefer to stay private, avoiding the quarterly-earnings circus and costs of financial governance.

Alibaba, LendingClub and King raised at least a half a billion dollars from their IPOs, but in private rounds this year, Uber (twice) and Xiaomi each raised more than a $1 billion and Magic Leap raised $542 million from Google and others. After their most recent rounds, Uber was valued at $40 billion and Xiaomi at $45 billion. Other private startups with 11-digit valuations include Snapchat, Airbnb, and Dropbox.

Facebook is the only other private company to raise more than $1 billion in a single round in the last five years, according to CB Insights data. (It raised a $1.5 billion Series E round in 2011.) The list of others raising rounds north of half-a-billion during this time include just Cloudera, Groupon, and Kronos, although the latter was formerly a public company. In other words, 2014 may be the beginning of a new trend of private megarounds that make it even easier to put off the allure of public market capital. Or it could signal a few ultra-hot companies operating outside of market norms.

If companies can raise money privately rather than publicly, what does it matter? There are two main issues. First, IPOs have long offered everyday consumers the chance to own a piece of the companies they helped build with their loyalty. Many of the IPO holdouts – Uber, Airbnb, Dropbox – have huge customer bases that aren't able to share in their success.

Second, it increases the chance of irrational valuations spinning further out of control. As carefully calibrated as valuations of private companies may be, the liquidity of the public market gives investors a quick exit should bad news surface. Yes, public markets often over- or under-estimate companies values, but the visibility and disclosure of financial information offers a safeguard missing in large private rounds.

It may be that some of the largest of these private tech companies find their way through the other side of the IPO queue next year. If so, 2015 could be a busier one than this year has been. But it could also be that they get creative about ways to stay private for longer, changing the way investors think about how they enter and exit the hotter investments in tech.