Natalia Holgado Sanchez
I am not sure about you, but lately I’ve been hearing the same chatter from friends and colleagues at startups. It’s usually a version of: “Will my equity ever be worth something?”
Let me start with the harsh truth: Nobody has a crystal ball to anticipate what the market will do or how it will impact private company stock. That may not be the most comforting thing to hear, but I also don’t believe it’s all doom and gloom. Another truth is that this is not the first market reversal, and it won’t be the last either.
For me, the comforting thing to do is look at the data. To better understand where we could end up, I like looking at the past and let history inform where we are now.
So, I looked at five market downturns over the past 20 years and analyzed how they affected private stock, and, most importantly, how long it took the IPO market to reopen. After all, at the end of the day, we’re all searching for the same answer: When will my paper wealth become liquid?
The crisis of 2002: The dot-com bubble
What happened?
Starting in the late ’90s, tech stocks started skyrocketing and were trading at all-time highs. Sound familiar?
Capital was extremely cheap to borrow as interest rates dipped as low as 1.67% (compared to rates in the last few years bottoming out at 0.25%). That spurred investments in riskier assets.
When the market started to collapse, prices were dragged down even further by accounting scandals, such as Enron in 2001, Arthur Andersen in 2002 and WorldCom in 2002.
While there aren’t as many financial scandals today, the environment back then was somewhat similar to what we’re seeing now.
What was different?
The similarities between today’s market and the dot-com bubble end there.
The dot-com bubble was not an economic crisis per se, and it was only contained to the financial markets. Plus, inflation wasn’t part of the molotov cocktail that is a major driver of what’s happening today.
What was the impact on startups?
Startups certainly took a hit. Private markets aren’t as transparent as the public ones, so to get better insight into what was happening, I like to look at the iShares Expanded Tech-Software Sector ETF (ticker IGV). This is an ETF that tracks technology companies — IGV is a basket of 119 software and interactive home entertainment and media stocks (Microsoft, Adobe, Salesforce, Oracle, etc.).
Even though it is not a 1:1 representation of private markets, since it is an ETF based on public companies, we can infer how multiples evolved during this time because there is a correlation between public and private markets.
Here’s what happened:
- The stock market dropped by 55% before the first IPO happened following the crisis.
- The EV/revenue multiple of IGV — a measurement that shows how much every $1 of revenue translated into valuation — dropped by 57%.
- The IPO market stayed shut for about 15 months.
- The first company to go public was Callidus in October, 2003, though it wasn’t the most successful exit.
- In June 2004, eight months later, Salesforce went public.
- One month after that, Google made its public debut on July 29.
We’re all pretty familiar with the stories of the latter two.
The crisis of 2008: The housing bubble pops
What happened?
Now let’s look at 2008, when we had our most recent major recession. Loan originators, propelled by cheap credit and lax mortgage policies, enabled the fast growth of subprime loans. That caused demand and valuations to skyrocket, creating a feedback loop of further investor demand and origination incentives.
But as interest rates began to rise and liquidity dried up, over-leveraged banks and funds began to rapidly unwind their portfolios. Valuations began to spiral and leverage levels started exploding.
The collapse of large institutions like Bear Stearns and Lehman Brothers took down the entire credit market, dragging down over-leveraged governments with it. The result was significant bailouts and austerity policies that reined in GDP growth and fiscal spending significantly.
The main similarities to today are that ultra-low financing opportunities enabled investors (both retail and institutional) to take on much more risk than they normally would through access to cheap capital.
What was different?
While the housing market was the major focus of the 2008 crisis, the drivers of the crisis today are actually much more complex. Back then, the major cause was a gigantic liquidity crunch. Today, both supply-side and demand-side shocks plague the economy.
While inflation peaked around 6% in 2008, the economy quickly entered a deflation of -2.1% as the liquidity crunch limited spending.
Meanwhile, unemployment quickly rose to 10.1% from 5%. The Fed had ample room for dovish maneuvering — or moves to actually grow the economy rather than limit it like today. The proof of this was when rates reached levels of 0.25% (similar to what we saw in COVID times), but inflation never spiraled.
There were no energy shocks or supply-side constraints hindering the Fed’s ability to control inflation. Furthermore, while the Fed did lower rates, they did not pursue an aggressive asset buying program and their balance sheet actually shrank by 4% during the 2008 crisis.
What was the impact on startups?
The housing sector dragged down the entire economy. Valuations dropped, but so did revenue forecasts.
More specifically:
- IGV Revenue multiples (EV/Revenue) dropped by 40%.
- The IPO window shut in August 2008.
- It opened nine months later when SolarWinds went public in May 2009.
- The door burst open in June 2010, with MakeMyTrip being the fifth IPO.
- The first companies to exit were typically seeing revenue growth of more than 30% and were cash-flow positive.
The crisis of 2016: Brexit, oil and Chinese uncertainty
What happened?
The U.S. didn’t have a recession in 2016, but the IPO window did shut again due to significant global economic uncertainty that affected markets.
Tumbling oil prices caused the economies of oil-producing countries to contract sharply, which pushed up yields on corporate debt, leading to defaults in the energy sector globally.
The Brexit vote also caused supply-shock fears that reverberated across Europe. Plus, slowing growth in China led to significant uncertainty (reflected in the Shanghai Stock Exchange Index falling by 43% in 12 months).
The only real similarity with today are the concerns over slowing demand from China, even though the dynamics driving the risks were very different.
What’s different?
There was no inflation — or recession — and the Fed did not play as large a role in what was happening.
The fears around Brexit have yet to materialize into anything serious. China has some ongoing disputes, but for very different reasons. At the time, the problems focused on the transition to a consumption-driven economy from one that was led by exports.
Meanwhile, oil prices have risen continuously this past year as supply struggles to keep up with demand for travel, consumption and production. But we’re hopefully starting to see a change.
What was the impact on startups?
There was no true crisis like in 2002 or 2008, but the uncertainty around a potential recession spurred a bearish sentiment in markets, which was furthered by the announcement of rate hikes by the Fed.
The impacts on startups included:
- EV/revenue multiples declined by 12%.
- The IPO window shut for six months.
- It was reopened by SecureWorks and Twilio listing and by Trivago going public later in the year.
The crisis of 2018: Debt, debt and more debt
What happened?
The federal monetary tightening that began in 2016 was starting to affect valuations as the Fed increased rates up to 2.25% from between 0% and 0.25%.
In addition, the U.S. economy was showing signs of slowing economic growth, propelled by an intensifying trade war between the U.S. and China, generating significant uncertainty in financial markets due to potential supply chain disruptions and higher production costs.
The S&P 500 in December 2018 fell more than 9%, as investors feared the Federal Reserve System was ready to turn off the tap for cheap capital and doubts about a potential recession started to emerge.
On the surface, 2018 might seem similar, but the reality is that a recession didn’t happen nor was there rampant inflation. The economic environment was a lot healthier than today’s, and the rate hikes were significantly more gradual.
What was different?
The Fed increased interest rates similarly to what we’re seeing now, but the efforts were more gradual compared to the multiple 75 basis point hikes we’ve seen. Moreover, the rate increases weren’t driven by high inflation or low unemployment. Instead, they were seen as a return to policy normalcy.
Additionally, the policy stance toward China was more of a trade war, as opposed to the cooperative one the Biden administration is currently aiming for.
What was the impact on startups?
The bearish market sentiment due to low earnings growth, supply chain disruptions and the simultaneous rate hikes did have some, if minimal, impacts:
- Revenue multiples were compressed by 37%.
- The IPO market quickly rebounded within five months.
- Among the first five companies to IPO were names like Zoom, CrowdStrike and Pinterest — all within three months.
The 2020 crisis: The pandemic panic
What happened?
The year 2020 was a socio-economic storm, the likes of which we have not seen before. The closest parallel was probably the 1918 flu pandemic, which preceded the Great Depression by a few years.
In March 2020, lockdowns to halt the spread of the COVID-19 virus exposed the over-extension of supply chains, razor-thin inventories and fragile business models. The U.S. GDP dropped by 5% for the first three months of 2020, and unemployment spiked to 14.3%, driven mainly by the restriction of business activity and supply chain disruptions.
Minimal ability to travel or the need for transportation brought the oil industry to a halt, bringing global producers and exporting nations under significant risk of default, which caused credit spreads to widen further.
Virtually everything about our current (maybe) recession is different from what we saw in 2020, in part because the environment today is the aftermath of reactionary government and central bank policies from 2020.
The only real similarity would be the stock market tanking by 45% in the first few months of 2020.
What’s different?
The recession was short-lived due to the U.S. government stepping in with PPP loans and ultra-loose monetary policy to tighten credit spreads and support economic demand for goods and services.
While there is no debate as to the critical impact this had on helping millions of homes stay afloat, there were some consequences.
Since people were trapped in their homes, savings ratios exploded as households had limited ability to consume or travel. Ultra-low interest rates meant banks could significantly expand their borrowing and lending capacity, and riskier investments started having increasing appeal for investors.
This trickled down into the startup economy, as investors deployed more and more capital into companies, enabling them to turbocharge growth by hiring and expanding their operations.
Now, this is not a bad thing, but the problem was that as the economy reopened, we were suddenly in a situation where people had strong savings and a pent-up desire to consume and travel.
Supply chains were not prepared to deal with this spike in demand, which was further exacerbated by oil production not being able to keep up with the spike in production of goods and services (freight costs spiked by 500% to $12,000, and oil prices skyrocketed by 60%). All this also hindered the ability to increase food supplies.
All of this ultimately resulted in inflation soaring above 8% (peaking at 9.1%), levels that we have not seen since the oil crisis in the 1970s.
What was the impact on startups?
The impact on markets was two-fold. Basically, the initial recession caused a sharp drop in multiples, while government programs, like PPP loans and interest rate cuts, rescued the markets.
More specifically:
- EV/Revenue multiples dropped by 30%.
- But the IPO window was shut for only two months.
- ZoomInfo was the first to open the window, going public in June 2020.
- It was soon followed by Lemonade, nCino, GoHealth, Jamf Holding and Vertex.
So what does this tell us about when IPOs will resume?
All of these downturns have one thing in common: The IPO window eventually reopened when the economy stabilized.
As public financial markets start to settle down — most likely due to the Fed’s policies starting to take effect — and supply chains and energy prices stabilize, we are likely to see an environment that rewards companies for going public.
Freight costs have already declined by over 70%, fuel prices appear to be stabilizing, and there are some promising signs that inflation is starting to come down. The softer language in recent Fed speeches is also a sign that the worst could be behind us.
Based on historical data, the IPO market has opened up after 18 to 24 months, on average. Given that we’re now about 9 months since our window closed, we could see movement by June 2023.
To be clear, this does not mean we are likely to see the blockbuster exits from 2021 coming back. There is still a long and bumpy road ahead, but there will always be public market demand for high-quality companies. The question isn’t “if” IPOs will come back; it’s “when.”
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