Midwest tech firms might skirt big valuation dips, experts say

For many private technology startups, 2015 was full of tailwinds that helped send valuations sky-high, including an eye-popping $51 billion valuation for ride-hailing service Uber.

Those winds have mostly subsided in 2016, and some investors have even moved to cut valuations. The impact of those trends on firms in the Midwest, however, should be fairly muted, according to industry experts at IBJ's Technology Power Breakfast on Thursday morning.

"I think it's pretty negligible, at least on a relative basis," said High Alpha partner Kristian Andersen, speaking about the pullback's impact on cities like Indianapolis, versus tech hubs on the East and West Coasts.

Outside the Midwest, industry leaders are forecasting depressed valuations and capital raises, and calling for companies to focus on bootstrapping and capital efficiency, Andersen said.

"That's essentially what we've been doing in middle America for the past 20 years, so this is not a new dose of medicine for us," he said. "We have been practicing those three things: raising money at reduced valuations, being more capital efficient, focusing on bootstrapping. We've spent 20 years building those muscles."

Company valuations can be determined a variety of ways, including as a multiple of annual revenue. Valuations in turn can play a pivotal role in helping investors determine how much they are willing to plow into a company in exchange for shares.

A recent Bloomberg investigation found that valuations can be based on slippery variables such as growth projections and a CEO's ego.

"For the most mature startups, investors agree to grant higher valuations, which help the companies with recruitment and building credibility, in exchange for guarantees that they'll get their money back first if the company goes public or sells," according to the Bloomberg article.

Large mutual fund companies like T. Rowe Price Group and BlackRock Inc. run funds that hold shares in private tech firms valued at more than $1 billion. A recent analysis by The Wall Street Journal found that a select group of mutual funds slashed valuations at 13 out of 40 such companies to prices below what they originally paid for those shares.

The average cuts were about 28 percent.

As The Wall Street Journal summarized, “The mutual-fund pullback threatens to deepen a wider downturn that has already led to falling valuations, shrinking ambitions and layoffs as the receding tide of capital forces startup companies of all kinds to focus on the bottom line rather than growth at any cost.”

Ting Gootee, the chief investment officer at Elevate Ventures, said that after the financial crisis, valuations surged nationally, reaching their peak in late 2014. At their peak, median valuations were at 10 to 15 times revenue. Now they have pulled back to more like six to eight times revenue.

“There is concern how this will trickle down to investors and portfolio companies,” she said. In a phone conversation, she said she has seen some local startups pare back their own valuations somewhat.

Angel Morales, co-founder of predictive analytics company SmarterHQ, said the valuations in central Indiana never have been so lofty. “We as an investment community look at value. It is not so much the hype.”

“We need to be judicious with every dollar invested,” he said, taking a pass on things like “super-cool laminated business cards.”

Andersen said corrections have benefits. It can allow investors to take advantage of bargains, deploying more capital or owning more of those companies.

"But also, I think it just strengthens companies and separates the wheat from the chaff," Andersen said. "So it becomes easier, frankly, for investors to figure out who's the real deal and who are pretenders."