Fidelity, BlackRock and other giants cut value of their stakes at faster pace, make fewer new investments
Rolfe Winkler and Scott Austin
March 3, 2016
Mutual funds that helped fuel the technology boom are cutting the value of their startup investments at an accelerating pace and are making fewer new investments.
These are ominous signs for Silicon Valley, where a flood of money into young companies pushed valuations skyward, and subsidized hiring sprees and advertising binges at scores of companies.
The mutual-fund pullback threatens to deepen a wider downturn that has already led to falling valuations, shrinking ambitions and layoffs as the receding tide of capital forces startup companies of all kinds to focus on the bottom line rather than growth at any cost.
BlackRock Inc., Fidelity Investments, T. Rowe Price Group Inc. and Wellington Management run or advise mutual funds that own shares in at least 40 closely held startups valued at $1 billion or more apiece, according to securities filings analyzed by The Wall Street Journal.
For 13 of the startups, at least one mutual-fund firm values its investment at less than what it paid, the Journal’s analysis shows. Those firms are valuing the 13 companies at an average of 28% below their original purchase price.
The companies include mobile-messaging service Snapchat Inc., note-taking software maker Evernote Inc. and health-insurance brokerage Zenefits.
Just three stakes held by the same fund firms were underwater a year ago.
Meanwhile, the fund firms bought only 10 new stakes in startup companies in the fourth quarter, down from a peak of 32 in last year’s second quarter, according to Dow Jones VentureSource.
The markdowns have stunned many venture-capital investors and blindsided some executives at startups.
Lower valuations by mutual funds could make it harder for all but the most successful companies to raise additional capital at richer prices and lead to more funding rounds at lower valuations. That can sap employee morale and hurt efforts to lure new hires with stock options.
“That level of reporting and transparency has never really been a part of the [venture-capital] market, and all of a sudden it came out and it was a shock,” said Jeff Richards, a managing partner of GGV Capital, a venture-capital firm based in Menlo Park, Calif.
GGV owns a stake in Web analytics firm Domo Inc., which has been marked down 16% by Fidelity since August. The mutual-fund firm still values the investment 72% above its purchase price.
Fantasy-sports company DraftKings Inc., also partly owned by GGV, tumbled in valuation by an average of 72% in the fourth quarter. Regulators have alleged its service constitutes illegal gambling. DraftKings said daily fantasy sports is a game of skill.
DraftKings declined to comment on the markdown. Domo didn’t respond to requests for comment.
Because shares in private companies aren’t traded on a stock market, the mutual funds must estimate how much each startup’s stock is worth, reporting the amount every month or quarter.
The reversal began in the last half of 2015 as the ebullient, sky’s-the-limit mood in Silicon Valley grew anxious. Collapsing tech stocks and the punishing market for initial public offerings are now reining in the runaway optimism that gave 146 venture-capital-backed private companies a valuation of at least $1 billion as of February, up from 45 two years earlier.
So far this year, Fidelity and funds advised by Wellington have marked down their estimated values of 13 different billion-dollar startups by at least 5%. No startups have been marked up by 5%.
In contrast, 14 startups were marked up in value in last year’s second quarter and only three were marked down, according to the Journal’s analysis.
The Journal created an interactive graphic, called The Startup Stock Tracker, that shows the estimated share prices for startups valued at more than $1 billion by big mutual-fund firms.
BlackRock, Fidelity, T. Rowe Price and funds advised by Wellington are among the largest investors in startups by dollars invested, though those stakes are tiny compared with the firms’ overall assets.
According to securities filings, startups have gotten at least $3.8 billion from Fidelity and T. Rowe Price alone, representing roughly 12% of the startups’ total funding.
The mutual-fund firms declined to comment on why their opinion of some startups is souring. When analyzing startups, independent valuation committees at fund firms usually sift through financial information from the company and valuations of publicly traded rivals. The committees also look at the share prices paid by investors in previous funding rounds.
Mutual funds depend on a vibrant IPO market to cash in on their private-company investments, usually made by buying stock directly from startups.
No U.S.-based, venture-backed technology companies have gone public so far this year. Last year, 16 such companies had IPOs, down from 30 in 2014. Their shares had fallen more than 30% on average as of mid-February.
The suffering stock market is likely to keep the IPO pipeline shut to companies that previously raised capital at lofty valuations and don’t want to go public at a lower price. Through Wednesday’s close, the technology-laden Nasdaq Composite Index was down 6.1% so far this year.
Many Americans own a piece of private technology companies through their mutual funds. Last year, about 45% of the funding rounds that valued a U.S.-based, venture-backed startup at $1 billion or more included a mutual fund, according to securities filings and data from Dow Jones VentureSource.
For example, securities filings show that Fidelity pumped at least $106 million into Zenefits last May as lead investor in a funding round that swelled the San Francisco company’s valuation to $4.5 billion.
The next day, Zenefits trumpeted the news in a recruiting note to potential employees. “In case you missed it, we just closed our EPIC series C of $500MIL at a valuation of $4.5BIL which makes us a UNICORN! That would be awesome for any company—but for a scrappy, two year old startup it’s LEGENDARY!”
In September, Fidelity marked down its Zenefits stake by 48% to $7.74 a share from $14.90. The cut left the company’s implied valuation at $2.3 billion.
Zenefits founder Parker Conrad was surprised by Fidelity’s move, according to people familiar with the matter. Zenefits called the mutual-fund firm to find out the reason for the cut, the people said.
Two of the people said Fidelity portfolio manager Steven Wymer attended Zenefits’s next board meeting. One person said he was asked about the markdown.
A Fidelity spokesman said an independent committee sets valuations for private-company investments, not portfolio managers.
In November, the Journal reported that Zenefits was falling short of its revenue targets and had started to curb expenses. Mr. Conrad resigned as Zenefits chief executive in February after coming under fire for what the company has said were inadequate compliance procedures and weak internal controls.
Last week, Zenefits fired 250 people, or 17% of its workforce. Zenefits declined to comment.
Andrew Boyd, head of global equity capital markets at Fidelity, said some executives at startups were surprised when the firm cut the estimated value of its investment. But few follow-up conversations have been contentious.
“They were looking for more clarity on how the [valuation] decision was made,” Mr. Boyd said.
Software company MongoDB Inc.’s finance chief sent a 500-word memo to employees after technology-news website The Information reported in August that Fidelity had marked down the company’s shares.
“Our public mutual fund investors have limited information about our business,” wrote Michael Gordon in the memo, which was reviewed by the Journal. “This is where the complexity and nuance comes in.”
Fidelity has cut its valuation of MongoDB in eight of the nine quarters since Fidelity made its investment in December 2013, valuing the shares 58% below what it paid. The software firm’s revenue roughly doubled to about $100 million last year, according to a person familiar with the matter.
But the company’s last valuation of $1.6 billion is a larger multiple of revenue than at publicly traded companies such as Hortonworks Inc., where revenue has been growing at a similar rate.
Fidelity now estimates that MongoDB is worth $6.98 a share. In an interview, Mr. Gordon said employees haven’t been focused on the markdowns.
Securities filings earlier this week show that Fidelity marked down in January the value of stakes in 13 of the 26 startups tracked by the Journal. The cuts included a 17% drop for software company Nutanix Inc., which filed in December for an IPO. A Nutanix spokesman declined to comment.
In a sign of Fidelity’s caution, the mutual-fund firm didn’t mark up in January the value of any startups tracked by the Journal.
Fidelity also is making fewer new investments in startups because it “couldn’t reach mutually acceptable terms as often,” Mr. Boyd said. The number of new stakes fell to six in the fourth quarter from nine in the third quarter and 16 in last year’s second quarter, according to VentureSource.
Fidelity did invest a fresh $175 million in Snapchat in February at the same price per share where the mutual-fund firm invested last March, according to a person familiar with the matter.
T. Rowe Price bought two new stakes in startups during the fourth quarter, down from five apiece in the previous two quarters. The two new investments by Wellington were its lowest total since the first quarter of 2014.
The BlackRock mutual funds made no new startup investments in the fourth quarter, according to VentureSource.
BlackRock said its valuations “are based on approved pricing methodologies and utilize multiple sources of information.” T. Rowe Price said in a statement: “What we are observing now is that the market appears to be bifurcating” into companies that are executing and those that aren’t. Wellington didn’t respond to a request for comment.
The mutual-fund firms analyzed by the Journal remain far ahead in paper profits on most of their stakes in privately held billion-dollar companies.
For example, mutual funds that invested in car-hailing service Uber Technologies Inc. at $15.51 per share now value the stock at triple that price.
Uber raised funding in December that valued it at more than $60 billion, a record for any private venture-backed company.
But some venture capitalists anticipate further markdowns by mutual funds. That could make some startups more reluctant to seek mutual-fund money, since public disclosure of their valuations is watched so closely.
Mutual funds often still value their startup stakes at higher prices per share than venture-capital firms do. BlackRock said data-mining software firm Palantir Technologies Inc. was worth $10.70 a share as of Sept. 30. That was 61% more than venture-capital firm Founders Fund’s valuation of Palantir on the same day, according to fund documents reviewed by the Journal.
In December, BlackRock increased its Palantir valuation to $11.38 a share. Palantir and Founders Fund didn’t respond to requests for comment.
Despite the markdowns, some tech executives see a silver lining. Mr. Richards, the venture capitalist at GGV, said lower valuations by mutual funds are helping him convince entrepreneurs to scale back their expectations.
“Here is some tangible evidence that the market has turned,” he said.
Insiders are starting to warily ask: Is this as bad as it gets?
Maybe-- tech is all hoping-- maybe the raise a shit load of cash at high prices and don’t go public strategy will work in the end for a majority of these companies if they cut their burn rate fast enough?
The answer likely comes down to founder discipline more than it does the markets. Many of the most overheated companies have very real businesses and customers and demand for their products. That includes Zenefits. The question is what expectation did they set for success, what price did they raise money at, what growth promises have they made investors, and what promises did they make employees.
Because stupid promises you don’t have to make can tank you. Stupid promises lead to stupid valuations and stupid expectations. That leads to very real downrounds (or worse) with very real employees with options worth nothing. Dropbox is a great business at some price. Evernote is a great business at some price. Even Zenefits could have been a great company if it weren’t obsessed with hacking its way to fast growth.
Groupon is worth more than $1 billion, but expectations made it a failure.
Ditto Zynga. For that matter, the single biggest problem with Twitter has always been grand expectations-- whether those the company set or the market set at its IPO.
Entrepreneurs claim the reason they fell into the trap of disclosing valuations-- and setting a bar by which so many are starting to disappoint-- wasn’t ego. It was because it made recruiting employees easier. Promises, valuations, cash. These have been the tools in nearly every “great entrepreneur’s” arsenal of the last few years.
It’s expectations and promises that start the downward spiral. Every unicorn has raised enough money during 2015’s spree of mega deals.
They should be able to survive if they can get off the easy fix crack.
Which is harder to stop: The burn rates or the promises and public posturing?
The best part of a Wall Street Journal article Monday which basically backed up everything Fortune had already written about downgrades was the indigence on the part of founders calling up to demand Fidelity et all explain their methodology for discounting the valuations. The embarrassment not of the downgrade, but that it was publicly disclosed.
There’s a rich irony in a founder who demanded a $1 billion valuation just because everyone else was getting one suddenly wanting a non-emotional, non-market-based reason for a downgrade. You can’t have it both ways.
While this has been the most over-heralded correction in recent Valley history, many entrepreneurs simply have never operated in an environment where raising capital was a challenge. Most assume the worst case scenario is a downround, despite there being little “social game” upside in VCs doing a downround versus just walking away.
Has anything changed in this era of austerity? Look at those three funding rounds I mentioned at the top. Founders are still disclosing unicorn valuations to the press. And even those that should know better keep making promises everyone knows they won’t be able to keep, creating an impossibly high bar for success for no good reason other than… what? Ego?
Witness an interview yesterday on CNBC with Shervin Pishevar. (Disclosure: A Pando investor.) He promised the Hyperloop would be operational within four years.
That’s right. An incredibly complex act of physics combined with huge financial needs combined with massive operational challenges combined with massive land acquisition (eminent domain scandals?) combined with regulatory challenges… that will all be solved within four years and we’ll be hurtling through tubes at 700 miles per hour. It will be operational before anyone thinks even self-driving cars will be mainstream?
His evidence? SpaceX. Which was founded in 2002 and still hasn’t come close to Elon Musk’s long-term vision of allowing him to retire on Mars.
There’s a reason Musk said the goal was “retiring” on Mars, not going on vacation to Mars in 2006. He never promised he could pull it off quickly, or at all. Only that it was his goal. His dream. That’s why it’s called a “moon shot.” To pretend we’re all suddenly smart enough or rich enough to “hack” moon shots in just a few years is the same thinking that took the Valley from a belief that $1 billion startups were “unicorns” because they are so rare to something everyone reached for well before their businesses could back it up, terms be damned.
And, why? Why set yourself up for failure?
The concept of the Hyperloop is amazing. We’d be impressed if you could do it in ten. Why set up a reason for everyone to say you failed? Why throw something out there that’s clearly unattainable?
Until the people giving these interviews, raising these funds, and responsible for the payroll of thousands of tech workers shift from this mindset, we haven’t found the bottom of the market yet.