Author, The Fairshare Model
With the pandemic induced havoc, how is that the stock market is not down more? And what effect will the economic downturn have on the valuation of startups?
In mid-April, when the Dow Industrials index was around 24,000, a friend with a predictive model for public stocks told me the market had priced-in the forthcoming bad economic news. He did not expect to see the Dow back at the 18,600 level it had hit a few weeks earlier. I had a hard time believing that, but the market hasn't validated my sense. It has remained stable as other economic indicators have worsened.
I’m not good at predicting the market—highs are higher than I think they should be, and lows are not as low as I believe they ought to be. Many people share my puzzlement.
This is the first in a trio of articles about expectations, and how uncertainty affects valuations in differently the public and private capital markets.
Classic thinking is that stock prices for established companies reflect actual performance, and that history suggests future performance. Of course, expectations that have no historic basis influence valuations too. Companies go public before they have revenue, let alone profit.
Expectations that affect valuations are being upended. Business models that were stressed before Covid-19 face potential collapse, while new ones are being viewed more soberly. For private companies with venture capital investors, an eventual exit — via IPO or acquisition — may appear more distant, and less valuable. This will cloud valuations for VC-backed private companies in the forthcoming quarters when they need to raise additional capital.
Dichotomies in valuations have always existed between the public and private markets, but current conditions may lead more people to wonder about them. Here are some thoughts that may reconcile Wall Street measures of health with reports of economic blood on Main Street.
This table highlights some of the valuation dynamics.
The high-level point I leave you with is that valuation is a tale of two cities—two markets, in this case.
One is set frequently in the public one, with participation of investors who think in terms of share price. But a valuation is more than that, it is the product of the share price and shares outstanding.
In the private capital market, a valuation is set infrequently by valuation-aware investors who insist deal terms that provide price protection.
Unfamiliar with valuation? Check out this YouTube video "Pre-Money Valuation: How To Calculate It.”
The references to my 2019 book, The Fairshare Model: A Performance-Based Capital Structure for Venture-Stage Initial Public Offerings, are dated—the video was created years before it was published.
This is the first of three articles that discuss corporate valuations and capital structures. The other two articles in the series are: