The rocket-ship story of cyber security company Wiz is the kind of thing that the venture capital industry has long relied on to draw in investors.
Four young engineers sell their first start-up to a giant tech company (Microsoft) and go off to found another. This one finds an unmet need and hits the big time: it quickly raises $1.9bn from some of the best-known names in venture investing. After just four years, a different giant tech company (Google) comes along and offers to buy it for $23bn.
If the sale goes through, it will be the kind of payday that enters VC mythology. But of late, big hits such as this have been few and far between.
The result, for start-up investors, has been a big overhang of ageing — and unsold — private tech companies. Unicorns — private tech concerns valued at $1bn or more — once earned that name because of their rarity. But there are now more than 1,200 of them around the world, according to CB Insights.
Until they cash in a lot more of those unrealised capital gains, many venture capital firms will find it hard to show the kind of strong cash returns needed to persuade their backers to put up fresh capital. That could well turn the unicorn logjam into a structural obstacle hampering the flow of new money into the latest wave of start-ups.
The problem has become more acute as tech stocks have stormed back from their post-Covid slump, but stock market listings and sales to other companies have remained subdued. In the US, there have been only four tech IPOs this year by companies valued at more than $1bn, compared with more than 70 in all of 2021, when the stock market was also hot.
Big acquisitions have also become scarce. As a result, billion-dollar “exits” by US tech start-ups number only 16 so far this year, compared with 211 in all of 2021, according to Crunchbase.
The VC world is split on whether this is primarily a problem of demand or supply. On the demand side, intense antitrust scrutiny has made it far harder for the richest tech companies to make acquisitions, meaning potential deals like Wiz are rare. Leaving aside Microsoft’s giant Activision purchase, total M&A by the five biggest tech platform companies has averaged a paltry $16bn a year over the past six years.
Yet even with the richest companies on the sidelines, sectors such as chips and software have been through waves of consolidation in recent years and companies like Broadcom have built tech empires on the back of aggressive acquisition strategies.
When it comes to stock market listings, meanwhile, the drought — interrupted only occasionally by booms like that of 2021 — has been a subject of concern in Silicon Valley for two decades. According to tech investor Coatue, it reflects a structural change in financial markets. As index funds have become a larger part of the overall stock market, according to this argument, there have been fewer active fund managers rewarded for sniffing out promising and undervalued businesses.
Others, however, counter that there is more than enough investment appetite, and that the problem has been more a shortage of the right kind of tech company. Lise Buyer, an IPO adviser who worked on Google’s IPO, says managers at many institutions are clamouring for growth tech companies to invest in, since holding the same seven big tech companies as everyone else leaves little room to outperform and justify their fees.
On the supply side of the tech start-up equation, many of the companies funded during the VC boom were fixated on unprofitable growth. That made sense when private investors demanded growth at all costs, but the stock market now demands a strong profit trajectory — something that takes time to build.
It is also taking time to work through the overhang from the last funding wave, following a collapse in private market valuations that set in at the end of 2021. Roughly half of the 1,200 start-ups listed by CB Index claimed a valuation of $1-1.5bn at their last funding round, making it likely that many would be better described now as ex-unicorns. Many of those will eventually fold or be sold at break-up prices.
Meanwhile, with Wall Street offering lower valuations than they once got in the private market, few founders of successful start-ups are eager to bite the bullet and rush to the stock market.
Investors who were eyeing a wave of tech IPOs this year have been forced to rethink. They are now starting to speculate over what might be in store for 2025. One of these years, they might actually be right.
richard.waters@ft.com