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How the Tech Market Rout Will Affect Business Valuations

As the air comes out of tech stocks, your business will lose value, too. Here's your reality check.
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Until very recently, tech stocks have been racing pretty high, pulling stock markets up with them as their valuations stretch.

But the air seems to have come out of that particular balloon. And I've been wondering how declining tech stock values will affect small-business valuations more generally. In a sentence: It's not looking good.

Below is an edited transcript of my enlightening discussion with Drew Nordlicht, partner and managing director of Hightower San Diego, an affiliate of Hightower Advisors. The firm manages $25 billion in assets of venture capitalists, private equity fund managers, chief executives, and entrepreneurs who founded companies that went public or received private equity funding. So, he's pretty plugged in.

Here's what he had to say about the stock market rout and what it means for you:

Drew Nordlicht, partner and managing director of Hightower Advisors, San Diego

Why have company valuations been so high? 
Drew Nordlicht:
 We have seen valuations become stretched, and investors in the IPO space have been paying top dollar for revenue potential, not necessarily earnings. Twitter is an example. Facebook is another. High valuation private companies have no choice but to go public and create a liquidity event. At those valuations, you limit the number of buyers. These are valuations we have not seen since 2000 in terms of price to revenue.

How much of this is related to Federal Reserve policy?
DN:
I think the Federal Reserve policy is the single biggest overriding influence in the public markets today. Quantitative easing policy, by depressing interest rates, has forced investment dollars to chase returns, not just yields, but return across the globe. Over the past several years, quantitative easing has taken money originally allocated for bonds, fixed income, and designated fixed return, and pushed it to take risks.

So what happens next?
DN: When you think about money flows and this type of financial depression of interest rates, you get a cascading effect. The first logical shift with your dollar is "I will not buy that 10-year treasury; I want a stock at 3 percent." And now that stock, because it has appreciated, is paying equivalent of only 2 percent. I have already realized appreciation, so is my dollar staying in that stock a better risk return than it is owning a small-cap stock. So here we sit today where the Fed is tapering; they are taking the training wheels off the bicycle and trying to see if we can ride on our own, although we have not seen a lot of growth yet.

If you look at this year, small-cap stocks are starting to produce large negative numbers. The S&P [index of large-cap stocks] is the only positive, major index.

What will happen with business valuations as we head back up the curve; will they get dragged down, too?
DN: Yes, you will see small caps suffer and see a revaluation. IPOs will feel the same brunt, and they already have. So far this year, in the tech space, the average tech IPO is at a loss, trading 15 percent below its initial price.

So how can small companies get the best valuations possible in the next year or so?
DN: They should listen to the advice of the professional advisers they have hired around them. My experience with fast-growth companies is that they have great attorneys, great investment banks, and sometimes they have great general advisers who most likely have a good foothold on what is going on in the markets. In any transaction, whether it is an IPO, a merger, or an acquisition, fight for a competitive valuation. Don’t fight for the premium valuation now.

Any time there is a retrenchment in the IPO market, you start to see valuations get beaten up, and that is starting to happen today. If you fight for the last dollar and a premium valuation, you might not get it, and six months from now, you might be regretting it, because valuations could be dramatically lower. When the IPO market takes a hit like it has, it takes a substantial length of time to recover, usually a couple of years.

 

Last updated: May 27, 2014

JEREMY QUITTNER | Staff Writer | Staff Writer, Inc. and Inc.com

Jeremy Quittner is a staff writer for Inc. magazine and Inc.com. He previously covered technology for American Banker and entrepreneurship for BusinessWeek.




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