Tech IPO market collapsed in 2022; next year doesn’t look much better

The Nasdaq Market Site in New York.

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After a record-breaking tech IPO year in 2021 that included the debuts of electric car makers Rivianrestaurant software company toastCloud Software Provider GitLab Spirit Hashi Corp and stock trading app Robin Hood2022 was a complete dud.

The only notable tech offering in the US this year was Intel’s split from Mobileyea 23-year-old company that makes technology for self-driving cars and was publicly traded until its acquisition in 2017. Mobileye raised nearly $1 billion, according to FactSet, and no other US tech IPO has raised even $100 million.

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In 2021, on the other hand, there were at least 10 tech IPOs in the US that raised $1 billion or more, and that doesn’t take into account the direct listings of Roblox, coin base Spirit Placewhich were so well capitalized that they did not have to bring in cash from outside.

The narrative turned completely on its head as the calendar turned, as investors shed the risk and promise of future growth in favor of profitable companies with balance sheets believed to be strong enough to weather an economic downturn and persistently higher interest rates. Pre-IPO companies changed plans after seeing their public market peers plunge 50%, 60%, and in some cases more than 90% from last year’s highs.

Overall, IPO deal proceeds fell 94% in 2022 — from $155.8 billion to $8.6 billion, according to Ernst & Young’s IPO report released in mid-December. At the time of the report’s publication, the fourth quarter was on track to be the weakest of the year.

As the Nasdaq Composite heads for its steepest annual drop since 2008 and underperformed the S&P 500 for the first consecutive years since 2006-2007, tech investors are looking for signs of a bottom.

But David Trainer, CEO of equity research firm New Constructs, says investors need to first get a grip on reality and evaluate resurgent tech companies based on fundamentals, not far-fetched promises.

As tech IPOs flew in 2020 and 2021, Trainer waved the warning flag and released detailed reports on software, e-commerce and tech-related companies that brought their sky-high private market valuations to the public markets. Trainer’s calls seemed comically bearish as the market rallied, but many of his picks look prescient today, with Robinhood, Rivian and sweet green each at least 85% below their highs in the last year.

“Until we see a sustained return to smart capital allocation as a key driver of investment decisions, I think the IPO market will struggle,” Trainer said in an email. “Once investors get their focus back on fundamentals, I think markets can get back to doing what they’re supposed to do: support intelligent capital allocation.”

Lynn Martin, president of the New York Stock Exchange, told CNBC’s Squawk on the Street last week that she is “optimistic about 2023” because the “backlog has never been this big” and that activity will pick up, as soon as market volatility sets in two resolve.

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Hangover from binge drinking last year

For companies in the pipeline, the problem isn’t as simple as weathering a bear market and volatility. They also need to acknowledge that the ratings they have received from retail investors do not reflect changing public market sentiment.

Companies that have been funded in recent years have done so at the end of an extended bull market, during which interest rates have been at historic lows and technology has fueled major changes in the economy. Facebook’s Mega IPO in 2012 and the millionaires coined by people like above, Airbnb, Twilio Spirit snowflake recycled money back into the tech ecosystem.

Venture capital firms, meanwhile, were raising increasing amounts of funds and competing with a new breed of hedge funds and private equity firms that were pumping so much money into technology that many companies chose to remain private longer than they otherwise would.

Money was plentiful. It wasn’t financial discipline.

In 2021, VC firms raised $131 billion, surpassing $100 billion for the first time and surpassing $80 billion for a second straight year, according to the National Venture Capital Association. The average post-money valuation for VC deals at all stages increased to $360 million in 2021 from about $200 million last year, the NVCA said.

Those valuations linger in the rearview mirror, and any company that raised money during this period must face reality before going public.

Some high-profile late-stage startups have already taken their nuggets, though they may not be dramatic enough.

Stripe cut its internal valuation by 28% in July from $95 billion to $74 billion, the Wall Street Journal reported, citing people familiar with the matter. According to the Financial Times, Checkout.com cut its valuation from $40 billion to $11 billion this month. Instacart has taken several hits, cutting its valuation from $39 billion to $24 billion in May, then to $15 billion in July, and finally to $10 billion this week, according to The Information.

Klarna, a provider of buy-now-pay-later technology, suffered perhaps the sharpest drop in value among the big-name startups. The Stockholm-based company raised $6.7 billion in funding this year, a discount of 85% from its previous $46 billion.

“There was a hangover from all that binge drinking in 2021,” said Don Butler, managing director of Thomvest Ventures.

Butler doesn’t expect the IPO market to improve significantly in 2023. The Federal Reserve’s continued rate hikes are more likely to push the economy into recession and there are no signs yet that investors are ready to take risks.

“What I’m seeing is that companies are looking at weaker B-to-B demand and consumer demand,” Butler said. “It will also make for a difficult year 23.”

Butler also believes Silicon Valley will need to adjust to a shift away from the growth mindset before the IPO market picks up again. Not only does this mean using capital more efficiently, demonstrating a short-term path to profitability and dampening hiring expectations, it also requires structural changes in the way organizations operate.

For example, startups have poured money into human resources in recent years to handle the influx of employees and aggressive recruitment across the industry. According to tracking website Layoffs.fyi, during a hiring freeze and in a market that saw 150,000 job cuts in 2022, there is far less demand for those jobs.

Butler said he expects this “cultural reset” to last a few more quarters, saying “that keeps me bearish on the IPO market.”

Money makes the world go round

One high-priced private company that kept its rating is Databricks, whose software helps customers store and cleanse data so employees can analyze and use it.

Databricks raised $1.6 billion at a valuation of $38 billion in August 2021, near the peak of the market. As of mid-2021, the company was on track to hit $1 billion in annual sales, up 75% year over year. It was on everyone’s list for the best IPO candidates to come of the year.

Databricks CEO Ali Ghodsi isn’t talking about an IPO right now, but at least he’s not raising concerns about his company’s capitalization. In fact, he says being private today is to his advantage.

“When you’re in the public eye, all that matters is cash flow right now and what you’re doing every day to grow your cash flow,” Ghodsi told CNBC. “I think it’s short-sighted, but I understand that’s what the markets are asking for right now. We’re not public, so we don’t have to live by it.”

Ghodsi said Databricks has “a lot of cash,” and even in a “heaven falls” scenario like the dot-com crash of 2000, the company would be “fully funded in a very healthy way without having to raise any cash.”

Snowflake stocks in 2022

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Databricks has avoided layoffs and Ghodsi said the company plans to continue hiring to capitalize on readily available talent.

“We are in a unique position because we are extremely well capitalized and private,” Ghodsi said. “We will pursue an asymmetric strategy in terms of investments.”

That approach could make Databricks an attractive IPO candidate at some point in the future, but the valuation issue remains an ongoing concern.

Snowflake, the closest public market benchmark to Databricks, has lost nearly two-thirds of its value since its November 2021 peak. Snowflake’s 2020 IPO was the largest ever in the US for a software company, raising nearly $3.9 billion.

Snowflake’s growth has remained robust. Revenue rose 67% in its most recent quarter, beating estimates. Adjusted earnings were also better than expected, and the company said it generated free cash flow of $65 million in the quarter.

Still, the stock is down nearly 20% in the fourth quarter.

“Sentiment in the market is a little tight,” Snowflake CEO Frank Slootman told CNBC’s Jim Cramer following the 11/30 earnings report. “People are reacting very strongly. That’s clear, but we’re living in the real world and we just go one day at a time, a quarter at a time.”

— CNBC’s Jordan Novet contributed to this report.

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