Examining True Valuation In the Wake of Disappointing Tech IPOs

A spate of valuations below expectations has many tech investors worried but the problem is likely just normal Silicon Valley volatility.

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By Tx Zhuo


Opinions expressed by Entrepreneur contributors are their own.

When Square set its IPO price at $9 this past November, the news drew disappointment and more than a little trepidation about the future of Silicon Valley. The $9 share price meant that Square's valuation came in nearly $4 billion under its projected numbers. And it's not the only tech giant to post disappointing figures recently.

Box, Hortonworks, Groupon and Zynga also made their public debuts at lower valuations than expected. The trend even sparked the grim venture capitalist saying: "IPOs are the new down round." Add to that rumors of dead unicorns, and it's easy to see why fears of a bubble are rattling the investment community.

But there's no reason to panic. People want to find a common thread between these companies so they can identify why their valuations were low and how other startups can avoid the same fate. There's no simple answer, however, and that should come as a relief. These are all very different organizations. It's difficult to know what influenced private investors versus public markets in each case.

Volatility isn't exactly a new phenomenon in Silicon Valley, either. Netflix often experiences wide swings in stock prices. High-risk speculation comes with the investment territory. Still, it's worth looking a little more deeply at what's going on behind these valuations.

Related: Etsy Reportedly Eyeing a $300 Million IPO as Soon as This Quarter

Don't call it a bubble.

People are terrified of another dot-com collapse, but there's a big distinction between a bubble bursting and a market correction. General tech observers get spooked by underwhelming IPOs because they envision the broad economic destruction wrought by other industry meltdowns. But corrections in private company valuations typically impact private investors alone, with public markets taking minimal hits.

The recent slowdown in the number of tech IPOs held each year has also upset the industry. But the decrease may simply indicate greater caution on the part of late-stage investors, not an impending doomsday scenario. VCs have good reason to worry that the public markets might never bear out massive private valuations, and they're wary of corrections that could cause them huge losses.

IPO price doesn't always indicate future outcomes. Zendesk's public valuation came in under a billion dollars but later hit a market cap of $2.23 billion. Hortonworks also enjoyed a resurgence in stock prices after its underwhelming IPO.

Due to the four- to six-month lockup period after a company goes public, it may be more relevant to examine an organization's value after it's cleared that hurdle. Inside investors can't freely sell shares during that time, so there's no way to know the actual returns until after the lockup period ends.

Related: Tinder CEO Sean Rad Makes Veiled Threat to Vanity Fair Reporter Ahead of IPO

Consider the future of valuations.

The tech industry isn't experiencing a bubble -- a paradigm shift in how companies fundraise is underway. Investors will be slower to back high-risk organizations that may not perform as expected in the market, and founders need to align their strategies with this shifting landscape.

Here are the steps required to build a valuation that doesn't frighten off prospects:

Hire an outside assessor. A realistic understanding of the company's assets and growth prospects helps everyone involved assess the risks and set their projections accordingly. Outside assessors can account for both financial and human capital looking at the company's earnings, as well as the leadership's experience and industry reach to come up with a well-rounded number separate from the emotions involved.

Set and meet your milestones. Milestone financing ratchets up valuation with each goal reached and helps build credibility for a company in the eyes of potential investors. Whether these milestones are based on technical developments or growth of clientele, crossing each one solidifies a company's future potential.

Build a battleground. The more investors there are vying for a product, the greater control a company has over setting the price. Bring as many potential investors as possible into the game in order to build a controllable, high-value market.

Public markets are highly dynamic. A company's price at IPO often is not a definitive indicator of where the corporation will be valued later that year or even that day. So while a low valuation isn't cause for celebration, it's also not a reason to panic. Fewer and slower IPOs aren't bringing a bubble to the tech world; they're heralding higher standards and a more responsible investing era.

Related: 6 Things You Must Do 36 Months Before Your IPO

Tx Zhuo

Managing partner at Karlin Ventures

 TX Zhuo is a managing partner of Karlin Ventures, an L.A.-based venture capital firm that focuses on early-stage enterprise software, e-commerce, and marketplaces. Follow the company on Twitter.

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