Leading up to DLA Piper's 2018 Global Technology Summit on October 9 – 10, 2018, Brad Gersich, Co-Chair of DLA Piper's Northern California Corporate and Securities practice shares some thoughts on dynamics he's noticed in the late-stage investment market.
Brad has more than two decades of experience representing emerging and established private companies through the venture industry's natural – and often volatile – peaks and valleys.
What forcing-factors are driving the strategy shift for funding later-stage private companies?
We have not enjoyed a robust market of public offerings for some time. Some of that is due to the challenges of dealing with activist investors and regulatory compliance; as a result, many folks are loathe to give up the flexibility you have to run your business the way you want to run your business as a private company. So if you can get the resources in a private placement that you can get from an IPO, without the cost and hassle of an IPO, the private placement looks awfully attractive.
Another element driving larger and more late-stage rounds is the sheer valuation that some of these companies are getting. There's just so much money going into companies in the Valley and beyond. And the money is being invested at very high valuations that are not always connected to traditional financial metrics at the company.
Finally, there is the influence of non-U.S. funds. In part because theseinvestors are not as networked with Silicon Valley or other traditional funding networks that support venture-backed companies, they are willing to pay higher prices compared to the rest of the market because some believe that's just what it takes to get in.
How are both late-stage companies and investors navigating these waters?
Investors must balance the desire to be part of an exciting deal and not be reckless—to be aggressive without being insane. Now, over the last four or five years, investors are asking themselves: can they rely solely on the traditional metrics they've used previously for decisions, or are they prepared to invest based on slightly different metrics? Or will they take the risk that a short-term performance trajectory is simply the start of a long-term performance trajectory?
As for late stage companies? They're often raising more money than they might actually need in the short term, given the attractive pricing they're being offered. Aggressive growth plans are being adopted. I'm eager to see whether they can achieve their ambitious objectives.
What are some typical last-mile hurdles for late-stage private companies?
The challenge is successfully balancing the desire for growth and the desire for profitability. If you're not profitable, then you're not truly independent because you're relying on somebody else to provide you with the working capital—whether it's through debt financing or traditional equity financing.
Even when late-stage companies are offering a product that customers want, and even with investors willing to invest based on a high valuation, the company may not raise enough capital to help cover all of the growing business' costs. Even if a business achieves profitability, management has to decide what to do with those profits. Are you funding further growth? Are you pushing out dividends? Are you adding a new product in your line? From an operations point of view, it is unique to each situation as to how the company wants to invest the money.
I also think there is a risk of hubris in the late-stage. Things have gone well enough that someone is recognizing you as a successful late-stage company deserving of attention, either from investor side, from the debt support side, or just generally the media side. Companies might start losing some discipline on spending, straying from their core mission and core products, and taking risks thinking they will be long-term value enhancements—but in the short term, those risks deplete resources.
Given all the change that's occurring in the late-stage investment space, how do you envision it continuing to change? Or will the current landscape remain for the next few years?
Our industry can move very swiftly. I've been doing this for 22 years, and have experienced the wild swings in at the beginning of this century. We've had extraordinary investing at high valuations, and then hit ugly collapses, dissolutions and shut downs. Then, we experienced a long, ugly hangover for a year or two before people were willing to start trying again in the venture space. We had to slow down, rebuild and come back with some discipline. I don't know if it will be in 6 months or 36 months, but I expect to see some cooling off.
It is my hope that we continue to have growth in the industry: more opportunities, and continued innovation and creativity. I hope we do not have a lot of investors and financial resources sitting on the sidelines. Still, there has got to be some sort of correction in terms of the enthusiasm. With a strong economy comes challenges in retaining employees. People have higher and higher expectations for their compensation, and that puts strain on budgets, which tends to have a long-term effect.
There is a lot of strong investment in seemingly strong companies in today's market for late-stage private investment. Lots of money is being raised at very high valuations. My hope is that any reaction to venture industry overheating is measured and gradual. There are enough veterans in the industry today who remember the experiences in the early 2000s to maintain some composure.
Brad Gersich will be moderating a panel – Better Late Than Never: A Discussion of Trends and Tactics for Financings Late-Stage Private Companies – featuring panelists such as Softbank Investment Advisers' Jeffrey Housenbold, among others, at DLA Piper's Global Technology Summit on October 9 at the Rosewood Sand Hill in Menlo Park.