When a Company’s ‘Path to Profitability’ Turns Out to Be a ‘Dirt Road to Doom:’ Term Sheet

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When I was first immersing myself into the world of tech reporting, I was confused as to why on earth you’d invest in a pre-product, pre-revenue, pre-pretty-much-anything-you-need-to-start-a-business company. “God, Polina, it’s about the potential upside of being so early,” they said. Ah. OK. 

My next question had to do with why investors would continue to back a company when there was no profit anywhere in sight. I was then informed that I wasn’t thinking like a venture capitalist. “It’s not about the profitability,” they said. “It’s about the growth and the path to profitability.”

We have now seen what happens when that path to profitability is actually a dirt road to doom. Venture capital firms of “unicorns,” or private tech companies valued at more than $1 billion, have a much higher tolerance for valuing fast growth over profitability, but that’s not exactly how things work in the public markets.

It turns out idealism is not a good substitute for profit. Neither is purpose, creativity, inspiration, energy, or happiness. I recently wrote about how Oprah-speak has become so common in S-1 filings that it’s practically become its own literary genre. Even so, there’s no alternative for good, old profitability. 

As Fortune’s Alan Murray noted in this morning’s CEO Daily, Peloton shares are trading 15% below their Wednesday IPO price. Seven of the year’s 10 biggest IPOs prior to Peloton are under water, having lost some $45 billion of their one-time value. The biggest losers? Lyft and Slack, down 53% and 42% respectively. The surprise winner: Beyond Meat, which is up 237% from where it started.

In the olden days, public market investors have typically expected companies to become profitable within 18 months or so of an IPO. This timeline has been loosened as fast-growing startups make their public debut with S-1s that warn: “We expect our operating expenses to increase significantly in the foreseeable future, and we may not achieve profitability.”

It’s somewhat of a celebrated mindset for entrepreneurs to have. Just last week, Peloton CEO John Foley said, “[Investors] want high growth — and in our case hyper-growth — so we plan to delight investors that see that our decision to prioritize growth over profitability is a good one.” On the day of his comments, Peloton’s stock closed 11.2% lower than the IPO price.

“In the public markets as a whole, profits do matter more than in the private markets,” Mark Mahaney, managing director at RBC Capital Markets, told me in June. “In the public markets, you’ll see a very broad range of investors — people who are willing to invest purely for growth and others who are looking for capital safety or capital accumulation. The general rule is that the public markets do have a stronger screen for profitability — or a path to profitability — than you have in the private markets.”

The average IPO return for 2019 has dropped to 6%, down from 30% at the end of June and 18% from two weeks ago. Recent deals suggest that public market investors have become much more selective about which money-losing companies to back.

“People’s radar for yoga babble is on high alert right now,” Scott Galloway, a marketing professor at New York University, told The New York Times.

So if a company’s CEO begins to sound like your “yoga instructor went into investor relations,” think twice before making your bet.

DIRECT LISTING HYPE: A group of Silicon Valley elite will meet for an invite-only event tomorrow in San Francisco to discuss “the benefits of the direct listing approach to a public listing.” (The direct listing allows shareholders sell existing stock directly to the public, leaving investment banks to serve merely as advisers in the process and not underwriters.)

Notable participants in the “symposium” include:
— Barry McCarthy, the CFO of Spotify
— Michael Lewis, the author of The Big Short, The Blind Side, and Flash Boys
— Michael Moritz, investor at Sequoia Capital
— Bill Gurley, general partner at Benchmark
— David Schellhase, general counsel at Slack
— Greg Rogers, partner at Latham & Watkins who worked on both Slack and Spotify’s direct listing

My colleague Michal Lev-Ram recently published a feature on the trend. She writes, “Longer term, perhaps direct listings will actually be a catalyst for more companies to go public, or to go public faster, which could have benefits for all involved—VCs, founders, investment bankers, and other shareholders.” Read it here.

VENTURE DEALS

Kenna Security, a San Francisco-based enterprise company focused on risk-based vulnerability management, raised $48 million in Series D funding. Investors include Sorenson Capital and Citi Ventures.

Moneyfarm, an Italy-based digital wealth management company, raised 36 million pounds ($44.4 million) in funding. Investors include Poste Italiane and Allianz Asset Management.

Beyond Pricing, a San Francisco-based pricing platform for vacation property rentals, raised $42.5 million in funding. Bessemer Venture Partners led the round.

AMBOSS, a Germayn-based medical technology company, raised €30 million ($33 million) in Series B funding. Investors include Partech, Target Global, Cherry Ventures, Wellington Partners, and Holtzbrinck Digital.

Gatsby, a Berkeley, Calif.-based platform for building websites, raised $15 million in Series A funding. CRV led the round, and was joined by investors including Trinity Ventures, Mango Capital, Fathom Capital, and Dig Ventures.

Kenzie Academy, an Indianapolis-based online and in-person coding school, raised $7.8 million in Series A funding. ReThink Education led the round, and was joined by investors including Revolution’s Rise of the Rest Seed Fund.

HEALTH & LIFE SCIENCES DEALS

Meissa Vaccines, a South San Francisco-based developer of vaccines to prevent viral respiratory infections, raised $30 million in Series A funding, from Morningside Ventures.

PRIVATE EQUITY DEALS

Blackstone Group will buy Colony Industrial, the industrial real estate assets and affiliated industrial operating platform of Colony Capital, for $5.9 billion. 

Transportation Insight, which is backed by Gryphon Investors, acquired TSG, a Suwanee, Ga.-based transportation management business. Financial terms weren’t disclosed.

Italmatch Chemicals, a portfolio company of Bain Capital Private Equity, agreed to acquire Water Science Technologies, a Birmingham, Ala.-based blender and chemical solutions provider for the North American oil and gas and industrial water treatment industries. Financial terms weren’t disclosed. 

Francisco Partners agreed to acquire Orchard Software Corporation, a Carmel, Ind.-based developer of laboratory information systems and healthcare software solutions. Financial terms weren’t disclosed. 

LLR Partners made an investment in Corestream, a Naples, Fla.-based platform for connecting employees with voluntary benefits. Financial terms weren’t disclosed. 

OTHER DEALS

Forever 21 Inc, a Los Angeles-based women’s apparel retailer, filed for Chapter 11 bankruptcy protection in the U.S. Read more.

Tencent will acquire a 29% stake in Funcom, a Norway-based video game development company. Financial terms weren’t disclosed. Read more.

IPOs

Anheuser-Busch InBev raised $5 billion from offering shares of its Asian operations through an IPO in Hong Kong. Read more

Vir Biotechnology, a San Francisco-based biotech focused on immunologic therapies for infectious diseases, plans to raise $150 million in an offering of 7.1 million shares priced between $20 to $22. It posted revenue of $10.7 million and a loss of $115.9 million in 2018. ARCH Venture Partners and SoftBank back the firm. It plans to list on the Nasdaq as “VIR.” Read more.

EXITS

Naxicap Partners will acquire Siblu Villages from Stirling Square Capital Partners. No financial terms were disclosed. Financial terms weren’t disclosed. 

Gryphon Investors said Sept. 30 that it agreed to sell its portfolio company ECG Management Consultants, a San Diego-based provider of strategic, operational, financial, and technology-related consulting services to health systems, to Siemens Medical Solutions USA Inc, a subsidiary of Siemens Healthineers AG. Financial terms weren’t disclosed. 

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