Pure Storage (PSTG), a flash media storage unicorn, was the first tech company to conduct an IPO in Q4 of 2015. Unfortunately, PSTG stock slid backwards after opening and didn’t recover until the following week. PSTG’s performance set off some alarm bells in Silicon Valley forcing another giant, Digicel, to pull their offering. These early data points for Q4 2015 aren’t a mere coincidence. Skyrocketing valuations, a record influx of private market capital and unstable public markets are making it a tough environment for the other $1B+ late-stage, private companies who were hoping to be next in-line to IPO. Like it or not, it’s time that the industry takes a hard look in the mirror and accepts that the party may be coming to an end.

Valuation Disconnect

According to Pitchbook, Series D valuations have increased from an average of $49M in 2009 to $185M in the 1^st half of 2015. Currently there is a large disparity between public and private market valuations. This becomes especially apparent when one compares public tech companies. Mahesh Vellanki, Investor at Redpoint Ventures did a phenomenal job of illustrating this disconnect recently.  Compared to 10-100x multiples that are often seen in the private markets, Yelp is valued around $1.4B (1.9x ’16 revenue), Etsy is worth $1.4B (3.8x ’16 revenue) and TrueCar just $400M (1.3x ’16 revenue). If I could enter into a short-Unicorn, long-public tech company pair trade right now, I certainly would.

Record Levels of Capital

Late stage investment dollars hit an all-time high of $14 billion in Q3 2015. According to Pitchbook, This is up 2x from a year ago and is also double the amount deployed into late companies during any quarter between 2010 and 2013. With more money flooding in, more companies have simply been staying the course and not jumping to sell or go public. These massive levels of capital have been driven by a structural change. Non-traditional investors (mutual funds and hedge funds) such as Fidelity, Tiger Global and Wellington, funded 30 late-stage deals this year compared to just 9 for the most active venture capital fund. The problem is that as soon as the market turns these non-traditional investors will be the first to disappear (and there are already signs that’s begun).

Exits are Drying-up

For the first time in 5 years, the amount of capital invested in 2015 is going to exceed the aggregate exit proceeds. If this isn’t a sign that we are in for pain than I don’t know what is. The National Venture Capital Association forecasted a 21% decrease in acquisitions of VC-backed companies in 2015 and a 55% decrease in IPOs of VC-backed companies. This is already starting to lead to a much more challenging fundraising environment for VC Funds themselves. According to Pitchbook, VC funds raised less than $4B during Q3 2015, the lowest amount of inflows since 2012. As we saw during the last downturn, when Limited Partners get skittish (or inherit a denominator problem as a result of a public market correction) that eventually ripples all the way down to private companies.

Only One Possible Outcome

Over the next 6-9 months late-stage private companies will need to gear up for a much more challenging fundraising environment. Attractive IPOs are going to be largely off the table for the foreseeable future. Therefore, late-stage unicorns are going to face three choices:

• Face down-rounds or highly structured deals.
• Accept acquisition offers they wouldn’t have previously considered.
• Focus on fundamentals- getting to profitability without relying so heavily on outside capital.

Late-stage investors will have a renewed focus on business fundamentals: revenue, margins, profitability and revenue/EBITDA multiples. That is ultimately healthy and not a bad thing. Don’t get me wrong, there are plenty of Unicorns that have built real businesses and can justify their growth expectations. But for the rest of them, it’s going to be a bumpy ride ahead.