Nutanix IPO shows risks of 'unicorn' valuations

SAN FRANCISCO (Reuters) - In the run-up to its initial public offering, cloud computing company Nutanix scrambled to avoid a situation that has increasingly marred technology IPOs: a price that is below the most recent private funding round.

After initially pricing shares at $11 to $13, a range that set the company up for a valuation nosedive, Nutanix on Thursday priced shares at $16 apiece. The higher-than-expected price values Nutanix at $2.2 billion, a boost from the $2 billion valuation it received in a 2014 private funding round.

Nutanix, which is unprofitable, begins trading Friday on the Nasdaq under the symbol “NTNX.”

Nutanix may have squeaked by, but public offerings at a price below the private market valuation, once a rare event, have become quite common, especially for venture-backed companies worth $1 billion or more - the so-called unicorns. Such low-priced IPOs have been often been followed by lackluster public market performance, and can lead to problems with employee morale, recruitment and retention, dealmakers say.

Of the 32 technology companies that went public with downrounds since the start of 2012, 53 percent are trading below their IPO price, based on an analysis of data provided by venture capital database PitchBook Inc.

Shares of payments company Square Inc, storage firm Box Inc, big data company Hortonworks Inc and solar energy operator Sunrun Inc, all of which had their valuations slashed, are trading between $5 and $8 below their private market valuation.

“That high valuation can really come back to haunt you,” said Nate Gallon, a partner with Hogan Lovells law firm.

In the most difficult situations, companies that IPO at a lower valuation can trigger an anti-dilution provision called a ratchet, which rewards later investors with more shares at the expense of employees and early investors.

Nutanix, which makes technology to improve storage and data center functions, has two ratchets that could have been triggered by a lower valuation on its public offering. In that case, early investors and employees would have been diluted.

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Nutanix declined to comment.

A study by law firm Fenwick & West found that, in 2014, 4 percent of IPOs had a ratchet that was triggered. In 2015, that jumped to 50 percent of deals. The Honest Company, Simplivity and DocuSign are among the other unicorns that are approaching IPO and also have ratchets, according to PitchBook.

“It’s safe to say that almost every (investor) now asks for a ratchet,” said Dave Peinsipp, a partner at Cooley law firm.

Many of those requests come from mutual funds, hedge funds and sovereign wealth funds, which in recent years have joined more late-stage rounds.

“If the company turns around and does a down IPO, those late investors don’t want to be left holding the bag,” Gallon said.

Some investors argue that, after the IPO, downrounds and ratchets are a distant memory. However, they can also signal deeper problems in the company.

“I don’t think you accept ratchets if you have a choice,” said Hemant Taneja, managing director at General Catalyst Partners. “What does it say about a management team that overshot its valuation? Some bad decisions made somewhere.”

For its Series B investment round, Nutanix chose Khosla Ventures because the firm offered a valuation of more than $100 million, said Mohit Aron, co-founder of Nutanix who left the company in 2013 to start a new startup, Cohesity. The firm obtained a $1 billion valuation with its Series D, which included a ratchet.

Compare that to software company Atlassian, whose valuation jumped 32 percent at its December debut and whose stock is up 44 percent. The profitable company did not raise any venture capital to fund its business operations, dismissing investors who came knocking with offers of bigger valuations.

“What would the point be? It felt that it became this vanity metric,” said Jay Simons, Atlassian’s president.

Reporting by Heather Somerville in San Francisco. Additional reporting by Lauren Hirsch in New York.; Editing by Jonathan Weber, Bernard Orr and Lisa Shumaker