By David Erickson
The following article was written by Wharton senior fellow and finance lecturer David Erickson. Erickson is also co-director of the Stevens Center for Innovation in Finance. Prior to teaching at Wharton, he worked on Wall Street for more than 25 years, helping private and public companies raise equity strategically.
At the peak of what was called the tech (or dotcom) bubble of 2000, there was an abundance of enthusiasm for the expansion and commercialization of the internet. We could now buy books, pet supplies, and toys from websites, even though it was still mostly via a slow dial-up connection. By March of 2000, Cisco Systems, the maker of much of the equipment that was driving internet infrastructure development, was the most valuable company in the world, valued at just over a half a trillion dollars. During 1999 and 2000, a record number of companies went public, from internet infrastructure companies to those names ending with a “.com” — such as Amazon.com, Pets.com, Toys.com — doing hugely successful IPOs, even though many of those were several quarters from making money (or even breaking even on a cash flow basis). Additionally, well-established companies from Disney to Walmart were exploring what they could do with their .com affiliates.
At the time, I was a senior capital markets banker working with many of these companies that had gone public and pitching the next wave of those that hoped to go public. By the summer of 2000, it became obvious that investor appetite was waning for the “next hot tech company” as earlier-stage companies were going public and starting to struggle. At the time, we were mandated with approximately thirty tech companies that wanted us to take them public, and I assumed our major competitors had just as many. I remember telling a colleague that the market was not going to hold up for another 100–150 companies to go public. (Having seen similarities to that period about eighteen months ago, I wrote a piece for Knowledge at Wharton titled, “Will 2020 Be Seen as the Year of the SPAC Bubble?”)
By the end of 2000, Cisco was valued at approximately a third of its March value. Over that same period, the Nasdaq composite was cut in half. Most of those companies that were hoping to go public didn’t get out, and many of those that did go public didn’t make it (including Pets.com and Toys.com) as they hadn’t raised enough money to get to break-even and the market collapsed making it hard for them to raise more. What caused the market collapse? Several factors contributed but with the common theme of “expectations gave way to reality.”
That same theme is probably true today. While many market participants have talked about the likelihood of the Fed tightening for over a year, factors such as the supply chain issues leftover from the pandemic and the impact of the Russian-Ukraine war have continued to drive inflation higher and exacerbated the impact on the equity markets. As of this writing, Nasdaq is down 30% and the S&P 500 is almost down 20% since their respective peaks a few months ago.
Just like in 2000, we had a record number of companies going public in 2021 — more than 550 that either did an IPO, merged with a SPAC, or did a Direct Listing. Also, like 2000, many of these companies were earlier-stage, high-growth companies that aren’t currently profitable (and many don’t expect to be cash flow break-even for several quarters). As of now, many have not raised enough capital to take them to break-even. Additionally, according to CB Insights, there are currently over 1,100 private “unicorns” (companies with a valuation over $1 billion) — many of which in normal market conditions would be considering going public in the near future. Unfortunately, in the years that followed 2000, it was scarce for earlier-stage, high-growth companies to go public, as the market remained much more selective for several years.
One big difference now compared to 2000 is that the size of the private equity market — and the availability of private equity capital for both private and public companies — has grown exponentially. According to Bain & Company’s Global Private Equity Report 2022, there was $1.2 trillion of new private equity capital raised in 2021. In 2000, the private equity capital available to these private and public companies was just a small fraction. While this is a tremendous amount of available capital, many of the private equity firms that were focused on late-stage growth/pre-IPO investments (such as the most prolific recently, Tiger Global) are shifting their focus to earlier-stage investing where there is less value degradation.
What Should High-growth Companies Do Now?
As with many situations, there are the “haves” and the “have nots.” The “haves” are those private and recently public companies that either have enough cash currently to get to break-even or still have access to additional capital (even at lower valuations, given the market’s fall over the last few months). The “have nots” are those private and recently public companies that don’t have enough cash currently to get to break-even and likely don’t have access to additional capital (even at lower valuations). One of the challenges for many of these “have nots” is they may have recently — in the last six to nine months — raised capital and not realized they don’t have access to further capital. As a benchmark, for newly public companies, it is usually very challenging to raise capital below your IPO price.
For the “haves,” the best advice is: execute, execute, execute. And as we tell our students in Wharton’s “Strategic Equity Finance” course, “Raise money when you can, not when you have to.”
For the “have nots,” it can be a lot more complicated. As we saw back in 2000, for those that weathered the crisis the best, the playbook was (and probably still is):
- Conserve cash. For example, if you currently only have 12 months of “cash burn” left, try to extend it at least a few more months.
- Work to move cash flow break-even earlier. If some of your capital expenditures/spending plans (for marketing, for example) assumed another capital raise, it might be better to defer some of those expenses until the money is raised.
- Refine or tighten your business model. Many of these companies heard over the last few years from their investors that expansion and a “growth at all costs” mentality were critical, but it should probably be replaced with a “growth with near term results only” mentality.
The challenge for all of these companies is that, unfortunately, nobody knows how long this correction and the corresponding change in financing appetite will last. But if what happened in 2000 is a guide, it was years, not quarters — in other words, much longer than most expected.