Several private, venture-backed companies have achieved rapid and extreme valuation mark-ups. This has obviously been going on for some time now in Silicon Valley and the private tech sector, but the magnitude and frequency of the recent write-ups has given me pause. I’ve been trying to piece together the ingredients that are creating this environment, and it comes down to the following: Scarcity, momentum, FOMO and gains:
Despite the fact that public market stock performance has been muted so far this year, private market valuations continue to surge upwards. Why this dichotomy? One big factor is scarcity. Private companies don’t raise money every day. If a VC wants to invest in a company, she may only get the option once a year. Given all the big funds that have been raised, fierce competition naturally ensues for these scarce slots in the most attractive companies. As a result, the prevailing logic of the winning bidder tends to be along the lines of “this might look expensive today based on fundamentals (or lack of fundamentals), but this will look like a great price down the road when this company is worth much more as it grows.”
Contrast this with public market investors who don’t face the same scarcity problem. There is a price every day for the shares of the companies in their universe. For public market investors, there is no scarcity, only a need to pick wisely and in a timely manner. As a result, valuations tend to make more sense based on current and near term future expected financial performance. Sure, there are expensive public stocks but, even for newly IPO’d companies with limited public floats, high multiples are driven by fairly broad-based demand versus a high price based on the winner of a scarcity auction.
Another reason the magnitude and frequency of write ups hasn’t abated (and may be increasing) is that the strategy of overpaying in the scarcity auctions for the most attractive companies has generally paid off. As more capital has entered the high growth, venture-backed “asset class” (it’s really more of an asset niche), the dynamics have only intensified. So, each time an attractive company has opened its gates to new capital, the ensuing competition has driven valuations even higher for the winning bidder. Emboldened by these write-ups, existing players have stayed aggressive and more new capital has entered the system. The momentum has continued to build.