Ten years ago, startups pulled capital from the capital markets. A startup raised money, executed for 12-24 months then sought more capital on Sand Hill, flaunting milestones to justify a higher valuation.
Today, a global investor base pre-emptively shoehorns dollars into the most attractive startups, saturating the balance sheet with cash every six to nine months. I call these mark-to-market rounds.
Mark-to-market rounds press private markets closer to public markets in three ways.
First, these financings establish a company’s value on a near-quarterly basis. Public companies are marked-to-market daily, but “more precisely” after quarterly earnings.
Second, mark-to-market rounds offer secondary. Investors furnish founders and early employees with cash in exchange for common shares. Secondaries are common for publicly traded companies, too; it’s customary to sell secondary six months after a startup’s IPO.
Third, investors price these infusions on multiples just the way a sell-side equity analyst would. Many investors extend the analogy by staffing a research arm. Their pdf output analyses the space, lauds the business’s prospects within it, and dissects relevant rivals. (link to 100x ARR)
The mark-to-market phenomenon fundamentally alters the board’s discussion of an investment proposal. Rather than debating if the offer fuels the financial plan fully, boards consider loftier questions.
- Will the quantum of capital and the headline valuation anoint the company the winner in its category?
- How might the brand of the leading investor bolster the startup’s market presence?
- What improvement in recruiting close rates can the company expect?
- Might the increase in 409a valuations offset that gain?
- Can the secondary improve employee retention?
- Is the business comfortable with a larger preference stack?
Mark-to-market rounds aren’t going away. In fact, we should expect more of them as the private market’s behavior asymptotes to the public market’s.
Some of our portfolio companies raise mark-to-markets annually or bi-annually as a matter of course to demonstrate strength, provide liquidity, forestall an IPO. Others leverage mark-to-markets as a defense against M&A. Still others forgo them altogether, not wanting to burden the balance sheet with excess assets. And last, some decide to negotiate the valuations lower, preferring a consistent and more modest price increase, and the confidence of knowing next year the business will be worth more, irrespective of a correction.
As passive venture investing continues to grow and venture dollars swell and swirl, each startup will need to define their own strategy of whether to entertain mark-to-market rounds and at which terms.