Why don't we have more IPOs?

Just a couple minutes before starting writing this I saw a tweet from Shriya Nevatia asking why don't we have more IPOs, and it reminded me about the disconnect between how people see investing in the startup space and in traditional finance. While there are many reasons behind this, there is one super simple one that investors in the startup space seem like they often overlook.

Before we jump into the IPOs themselves let's first have a look at the most common ways we do valuations in the public market.

DCF - Discounted Cash Flow

This basically projects out the expected cash flow the startup will have and then applies a free cash discount rate.

Comps - Comparable Companies

Be it in MnA transactions or public companies, you take the EBITDA or the PE ratio of similar companies in the industry, figure out the multiplier on those compared to valuation, and then apply that multiplier to the startup.

Asset Based

This one is the simplest. Take all the assets, subtract liabilities, and boom done.

Now, a startup ain't gonna have tons of assets so that one is not gonna be used, comps are cool, but everyone knows that the market is overall down if you take out the AI hyped companies, which leaves us with a DCF.

When it comes to a DCF the thing that will effect basically every company is the free cash discount rate. There are a couple ways people calculate this, but the lazy way to do this is just take the interest rate of 30 year US treasuries or the Fed actually gives us an indicator from which we can just pull the US discount rate.

In 2022 this discount rate was 0.25%, today it is 5.5%.

Now if you are taking a billion dollars in free cash flow over let's say 5 years, that company would have a valuation of about 980 million in 22. You take the exact same company today the valuation would be around 760 million. This means that 2 years ago the valuation would have been about 30% higher without changing anything else.

Add onto that the overall economic situation where you would probably add on a pretty considerable market risk premium and specific risk premium, and you can easily end up with a discount rate of 15% if not higher which means 2 years ago the valuation for that startup in the public market would be double.

With this in mind in can be pretty easy to see why most VC investors would be hesitant to push for IPOs in the current market when they can just leave companies marked at their last rounds valuations making it easier to raise their next fund.

Much in the same way there is less incentive for the startups to IPO as well since an IPO is just another round of investment for a company and many don't wanna take a significantly worse deal such as this.

*market risk premium -- overall risk for the current market

*specific risk premium-- risk for this company, likely high due to it being a startup and not proven with several decades of history