The $9 trillion loss on Nasdaq and the ticking time bomb on startups
Private company founders will have to face down rounds and contracts with so-called ‘dirty clauses’
The changing mood of the market with the technology universe, which destroyed no less than US$ 9 trillion of the market value of companies listed on Nasdaq this year, put a ticking time bomb in the laps of several startup founders. After the price adjustment in publicly traded companies, the correction in private companies that made funding rounds with astronomical valuations seems inevitable.
And at this point, what no one counts is that seeing the screen value melt for a period may be the least of the problems a founder can face. Being a listed company, for him, can be a solution — not a problem, even if it’s not pleasant. To get an idea of the size of the adjustment to come, the Swedish fintech klarnafamous for taking digital installment plans to Europe, with buy now, pay latter, could suffer a $15 billion dow round.
The information is from the Wall Street Journal. The company raised funds last year valued at US$ 45.6 billion, and it seems that to raise US$ 1 billion now, it would have to accept a price of US$ 30 billion – even if it tries to achieve US$ 50 billion in value.
Few people know, but a down round can have many implications for founders, due to clauses in contracts with investors who entered at a high price. These are called “dirty clauses”. It is difficult to know how widespread they are, but their objective is to protect funds and their shareholders from devaluations, as companies are closed and they cannot sell their holdings so easily.
There are two most common clauses: an anti-dilution clause and a liquidation preference clause. In the first one, when a company capitalizes at a value lower than the previous round, the founder (who usually has a different share class) needs to hand over part of his position to funds that paid more, as a way of avoiding the dilution of the slice of them. Therefore, founders lose part of their ‘wealth’, which is used to compensate those who bet on the business.
The preference clause in case of liquidation, on the other hand, is for situations in which a company is purchased for a value below higher rounds. It is common for mergers and acquisitions to accelerate in scenarios with little money in the market. In this scenario, the ones who receive the most — that is, the cup that needs to be filled first — are the investors, not the founder. And there are cases where no one makes money in these situations. At least, not right away.
In the boom scenario, investors are less greedy for these rights. But now, given the capital restriction, the tendency is for this type of clause to become a more common requirement and to spread more quickly. This dynamic could send startup founders rushing to an IPO at the slightest sign of improvement. For investors, the upcoming season, therefore, will require extra attention to understand the motivations of a listing. And why rush to the bag?
“The only way to dismantle all this is to go into an IPO,” says the founder of a Brazilian startup that listed its shares on B3 during the pandemic season. For him, it’s time to forget about the price on the screen and look inside the trade. The money to do the necessary is already in the house.
When the company goes public, all investors have the same type of share with the same rights because the Brazilian Corporate Law doesn’t even allow otherwise — in addition to the common (with voting) and preferred (non-voting) types. But, in general, companies choose to make an initial public offering listed on the Novo Mercado, where only those with capital made up exclusively of common shares are accepted.
For those who took advantage of the recent listing frenzy, the correction came strongly. THE Nubankfor example, is currently valued at less than US$18 billion — well below the US$41 billion used as a benchmark in the IPO, and also the two previous rounds, when it received valuations of US$25 billion and US$30 billion, in January and October 2021.
The main startups that made an IPO on B3, such as Méliuz, sick and getNinjas, all suffered strong devaluation. Not even Locaweb, which was already considered more mature, escaped: the value of the company fell from R$ 20 billion to R$ 4 billion, without changes in the business plan. (But it has reached a point where it has already attracted one of private equity’s most renowned giants, General Atlantic. The manager built an 11% equity position on the back of the price drop.)
All of these are heavily capitalized and with the founders calm to run the business with a focus only on beating the sufficiently hostile environment of the Brazilian and global economy. They don’t need to put on their agenda how to find ways to protect their own assets.
For those who stayed in the private market and didn’t ride the IPO wave, the challenge is threefold: growing to deliver what was already promised, finding more money and avoiding a down round.