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As 1Password Goes the VC Funding Route, Public Markets Push Back

Nov 16
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1Password, the privately owned Canadian company that so much of the world (both individuals and corporates) rely on for effective password management has taken its first ever dip in the waters of outside investment, this taking $200 million in “Series A” funding from Accel. What is perhaps most shocking about this is that 1Password is something of a rare figure in the world of tech startups these days, a firm which is profitable.

I put quotes around Series A in the first paragraph because although technically this is Series A funding (first round of venture capital funding), it’s also a somewhat odd situation because 1Password is already a sizeable company and profitable. If it genuinely needed financing, in general at this stage of its evolution as a company it would probably be considering going public, but what we have here is yet another case of markets being somewhat skewed from their traditional roles.

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Fundamentally, the routes for funding of companies has changed a lot in the last decade. Venture capital and private equity were always around of course but the nature of these strategies has changed, in large part because of the arrival of SoftBank (TYO:9984) on the scene. Like a big stack poker bully, SoftBank has wielded huge sums of money, throwing its weight around the tech financing industry in so many companies that its competitors in the VC/PE stakes (technically SoftBank has taken both roles in at various times), have needed to also up the ante.

Bill Gurley recently hosted a forum in the Valley talking about how private companies should shun public markets for a variety of reasons. Of course, he’s talking his own book (as are most people) given that his firm (Benchmark Capital) is in the game of investing in private companies, but there are definitely arguments on both sides of the table here.

Public and Private Markets are Currently Skewed

There are a number of factors contributing to some of the odd behaviour in the markets at the moment. Part of it is the record low global interest rates. Surprising given that we’re in the midst of a decade of growth in the global economy and the longest bull market run in history. This recently led to Apple (NASDAQ:AAPL) issuing a staggering $7 billion in debt, this when it has an already ridiculous cash pile of about $200 billion (although this is down from its peak as the company spends on original content for its TV offering and other areas).

One of the main reasons Apple borrowed when it has such a huge cash pile is of course because interest rates are so low. Given the combination of low interest rates, huge venture capital and private equity funds throwing cash around like it was going out of fashion and public markets hitting constant new highs (the Dow Jones Industrial Average, S&P 500 and Nasdaq Composite all closed at new record highs yesterday), it’s no surprise that we are currently in the midst of a glut of capital raising of all kinds.

However public markets are the first to have really pushed back in the form of the WeWork debacle. A lot of tech companies have been going public while losing lots of money and having no clear path to profitability. Although most of them have had successful IPOs from the perspective of raising cash, there have also been a number of unsuccessful IPOs from investors perspective as many of these companies are trading close to or below their IPO placing price. WeWork and its failed IPO/subsequent bailout by SoftBank were the first sign of a pushback where investors genuinely seemed to question the story they were being told by the IPO underwriters and not agreeing to just pony up cash without question for once, unsurprising in a year which saw Uber (NYSE:UBER), Lyft (NASDAQ:LYFT), Slack (NYSE:WORK) and Peloton (NASDAQ:PTON) go public to muted indifference or punishment by the market.

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The relatively recent additions of crowdfunding and tokenisation to the mix of routes for private companies to access retail money without granting investors the protections or voting rights associated with public markets is also problematic and another way companies can raise funds without having to go through the requirements of public listings.

Wrapping Up – Companies Need to Get Back to Fundamentals

Also in the last week, Stacey Cunningham (President of the New York Stock Exchange), wrote an opinion piece for Bloomberg (here) cautioning against companies avoiding public markets and choosing to remain private for longer. Cunningham of course is also to a certain extent talking her own book in that she runs a stock exchange, but she also makes good points and is likely at an exchange as she believes in the integrity of public markets. Public scrutiny is one of the most reliable ways to both insure investor protection and retail investor accessibility to companies and the growth of capital that good companies can give to investors.

Companies can certainly find public markets daunting or not ideal in their appraisal of them, as was demonstrated by Dell (NYSE:DELL) going private to reorganise its business and then subsequently listing again, but by and large the accessing of public money provides benefits all round, to companies as they ensure governance and reporting standards, pushing them to achieve and maintain profitability as well as providing investor value whether it’s for someone’s brokerage account or 401k/other retirement planning vehicle.

The relatively recent focus on just gaining market share and growing at all costs, even to the detriment of eventual profitability is a problem and public scrutiny often ensures what should be a reasonable balance between growth and profits.

Perhaps a rethink from Congress/the SEC on the levels of outside investment and assets that a company has before it has to file earnings reports with the SEC would help. Currently, a private company must report its earnings to the SEC when it has more than 500 external investors and $10 million in assets, which often leads to private companies only allowing external investors to come onboard as long as they can keep the total number to less than 500, sometimes buying out other shareholders to keep the numbers low. The difficulty is that these kinds of opaque transactions erode investor protections as the price forming power of public markets is nowhere in existence.

Coming back to 1Password then, some on Twitter are uncomfortable with the company pursuing outside investment they think it might not need with the pursuit of external funding even being regarded as leading to poor decision-making in the pursuit of profits. Basecamp cofounder and CTO/NYT best-selling author David Heinemeier Hansson had this (and more on the thread) to say:

The valuation of the company wasn’t made public as part of the deal, but with the market as toppy as it is right now, you can bet it wasn’t low. Other important tech companies like Palantir were previously expected to go public but now are remaining private. Palantir was valued by Morgan Stanley last year as being worth about $6 billion, although reports of it pursuing private funding this year apparently put the value at around $26 billion. These huge spreads in valuation simply aren't present when the volume of liquidity is so huge in public markets and as such, valuations tend to be much more accurate. The VC cash hasn't run out yet, but when a recession comes and private money dries up, public markets will again be the route of choice and the focus on company fundamentals will again come to the fore as weak companies go under where today they may not.

Full disclosure, I work for a stock exchange and generally also have an interest in public markets.

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