I am not sure about you, but lately I’ve been hearing the same chatter from friends and colleagues at startups. It’s usually some version of, “Will my net worth ever be worth anything?”
Let me start with the hard truth: No one has a crystal ball to anticipate what the market will do or how it will affect private company stocks. That may not be the most reassuring thing to hear, but I don’t believe it’s all doom and gloom either. Another truth is that this is not the first market reversal, nor will it be the last.
For me, it’s reassuring to look at the data. To better understand where we might end up, I like to look to the past and let history tell us where we are today.
So I looked at five market downturns over the last 20 years and analyzed how they affected retail stocks, and more importantly, how long it took for the IPO market to reopen. In the end, we are all looking for the same answer: when will my paper assets become liquid?
The crisis of 2002: the dotcom bubble
Starting in the late 1990s, tech stocks started skyrocketing and trading at record highs. Sounds familiar?
Capital was extremely cheap to borrow as interest rates fell to just 1.67% (compared to rates that have bottomed out at 0.25% in recent years). That encouraged investment in riskier assets.
As the market began to collapse, prices were dragged even further down by accounting scandals such as Enron in 2001, Arthur Andersen in 2002 and WorldCom in 2002.
While there aren’t as many financial scandals these days, the environment back then was somewhat similar to what we see now.
What was different?
The similarities between the current market and the Internet bubble end there.
The dotcom bubble was not an economic crisis in itself and was limited only to the financial markets. Moreover, inflation was not part of the Molotov cocktail that is a major driver of what is happening today.
What was the impact on startups?
Startups have certainly taken a hit. Private markets are not as transparent as the public ones, so to better understand what happened, 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 package of 119 software and interactive home entertainment and media stocks (Microsoft, Adobe, Salesforce, Oracle, etc.).
All of these downturns have one thing in common: the IPO window eventually reopened as the economy stabilized.
Although it is not a 1:1 representation of private markets, as it is an ETF based on publicly traded companies, we can deduce how multiples have developed over this period as there is a correlation between public and private markets.
This is what happened:
- The stock market fell 55% before the first post-crisis IPO.
- IGV’s EV/Revenue multiple — a measurement that shows how much every $1 of revenue translated into appreciation — fell 57%.
- The IPO market remained closed for about 15 months.
- The first company to go public was Callidus in October 2003, although it was not the most successful exit.
- In June 2004, eight months later, Salesforce went public.
- A month later, Google made its public debut on July 29.
We are all quite familiar with the stories of the latter two.
The 2008 crisis: the housing bubble bursts
Now let’s look at 2008, when we had our most recent major recession. Lenders, propelled by cheap credit and lax mortgage policies, enabled the rapid growth of subprime lending. That caused demand and valuations to skyrocket, creating a feedback loop of further investor demand and incentives for new investment.
But as interest rates began to rise and liquidity dried up, overleveraged banks and funds began to rapidly wind down their portfolios. Valuations started to rise and leverage started to explode.