WeWork and other top startups were cut down to size in 2019. This VC thinks 30% of the more than 400 other unicorns will soon see their valuations slashed too. (UBER, LYFT, WORK)

December 29, 2019

WeWork and other top startups were cut down to size in 2019. This VC thinks 30% of the more than 400 other unicorns will soon see their valuations slashed too. (UBER, LYFT, WORK)

Silverton Partners General Partner Morgan Flager

Some of the biggest private or recently private tech companies — including Uber, WeWork, and Slack — saw their valuations slashed in 2019.
Dozens of other unicorns — private companies with a valuation of $1 billion or more — will suffer the same fate in coming years, predicted Morgan Flager, an Austin, Texas-based venture capitalist.
A flood of money into the private markets has bid up values of many startups to unsustainable levels, Flager said.
In some cases, investors have mistakenly identified companies as tech firms and assigned them sky-high values they arguably don't deserve, he said.
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This year saw the humbling of some of the best-known unicorns — startups with a valuation of $1 billion or more.

Uber, Lyft, and Slack all saw their valuations fall after they went public, and Uber debuted at a far lower price than expected. Meanwhile, things were so bad for WeWork, it couldn't even go public, despite repeatedly slashing its valuation, and ended up needing a $9.5 billion bailout from SoftBank just to stay in business.

Morgan Flager thinks such companies won't be the last unicorns to be disgraced. Over the next three years, 30% of the more than 400 companies in the $1 billion valuation club will see their worth officially challenged as they raise new funding, predicted Flager, a general partner with Austin, Texas-based venture capital firm Silverton Partners. They'll either have to raise funds at the same valuation they were assigned perhaps years before, or they'll have to swallow being tagged with a slashed value, he said.

"You have a lot of these companies that have raised on very high multiple valuation metrics and now have to go to market with a slightly more skeptical group of investors," Flager told Business Insider. "In a lot of cases when that happens, it's a win to get back to the valuation or metric you had before."

Flager declined to name any particular unicorns that he thinks are heading for a fall. But in general, the startups that are at the biggest risk of being humbled are those like WeWork that may employ software or other technology in their businesses but fundamentally operate in other industries, like consumer packaged goods or real estate, he said.

Even though those industries are typically less profitable than the software business and investors generally haven't paid the same kind of premium for them as software firms, such "companies are getting [similar] kinds of valuations," Flager said.

WeWork opened investors' eyes

The dramatic decline of WeWork in particular has likely awakened investors to the folly of that notion, he said. In a funding round in January, SoftBank valued the real-estate giant at $47 billion. As it prepared for an initial public offering this summer, WeWork's bankers were pitching it on the idea that the public investors could value it even higher.

Instead, investors pushed back against the offering, alarmed by the company's huge and ballooning losses and by some questionable transactions involving its CEO, Adam Neumann, and his family members. The company eventually cancelled its offering, missing out on a much-needed chance to replenish its coffers. Weeks away from bankruptcy, it got a bailout from SoftBank that valued the company at less than $9 billion.

That "kind of opened some people's eyes, in terms of the potential peril of applying those valuation metrics to businesses that, some would argue, historically have not seen that level of valuation and whose business models don't necessarily justify it," said Flager, whose firm focuses on investing in early-stage startups that are based in Texas.

The unsustainably high valuations of some unicorns have been driven in part by that mistake that some investors have made of confusing those companies that don't really deserve to be considered tech companies with bona fide tech firms, he said. But there are other factors at play.

A flood of money has raised valuations

Much of the rise in the value of startups has come from the flood of capital into the private markets, he said. With a surplus of capital, investors are bidding higher to be a part of deals, especially for companies that seem to have the potential to be worth tens or even hundreds of billions of dollars.

The inflation of valuation also stems from a mismatch between the perspectives of private and public investors, he said. Private investors tend to have longer time horizons and are often more willing to tolerate losses and investment for longer periods of time than public shareholders. Those private investors have been much more willing to buy into the vision presented by such companies that they'll be able to post healthy profits once they get bigger and have a more dominant position in the market, he said.

"That vision of when that's going to happen tends to be a little bit far out in the future for a lot of public market investors," Flager said.

While the overvaluation of companies such as WeWork and Uber has gotten the most attention, the trend has affected the whole venture industry, including the Texas startup scene and the early-stage market on which Silverton concentrates, he said. Valuations in Austin have risen about 60% to 70% in the last eight years, he said. And Silverton has had to be more selective about its investments.

In some cases, it's been outbid on particular deals because the price got too high, Flager said. Earlier this year, Literati, one of its portfolio companies, was seeking to raise a Series A round. Silverton intended to lead the deal, but the round became too pricey. Shasta Ventures ended up leading the round in the book-club service provider, and Silverton just invested enough to maintain its percentage stake in the company, Flager said.

Silverton is "selectively walking away from investments where we think they're on the higher end of...this valuation change that's happened," he said. "But we're still paying higher prices on average than were, even 4-5 years ago, and, I would say, significantly higher."

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