Choppy Waters for IPOs: Startups Struggle Amidst Rising Interest Rates

Last year was brutal for startups and the initial public offering (IPO) market, as the recessionary headwinds coupled with the rising interest rates dissuaded venture capitalists and investors alike. 

While investors cheered a surprising IPO market comeback with British chipmaker Arm Holdings' ARM listing on the Nasdaq Stock Exchange and grocery delivery app Instacart's CART debut on the New York Stock Exchange, both stocks wobbled soon after their listing. Arm stock plummeted by nearly 15% since its listing on Sept. 14, while Instacart plunged by over 24% since its IPO on Sept. 19. 

"It's definitely been a little bit of a choppy reception. They've all kind of traded down from their first open," Renaissance Capital Research Director Nick Einhorn said. 

"And I think that goes to some of the skittishness in the market generally, obviously, with the Fed meeting this week and the potential government shutdown. But also, I think it just shows that IPO investors are still not totally convinced that the IPO market is back. They're a little jittery. Maybe some of them are taking gains early once these companies priced up."

Don’t Miss:

• Until 2016 it was illegal for retail investors to invest in high-growth startups. Thanks to changes in federal law, this Kevin O’Leary-backed startup lets you become a venture capitalist with $100.
• It used to take a fortune to own premium bottles, but right now, $25 is enough to get started in this $229.4 billion asset class.

Fed's Continued Hawkish Stance: A Major Barrier 

The Federal Reserve's plan to keep raising interest rates in the near term has been a major deterrent in the IPO space, as companies are worried about keeping up with the rising borrowing costs. 

Startups are typically valued based on their cash flow expectations, making the current hawkish backdrop unfavorable for IPOs. As growth expectations and funding availability remain low, even the most promising startups are being valued modestly. 

"It's a valuation game and what we're all trying to figure out right now is, what are they really worth?" said Ray Wang, founder and principal analyst of Constellation Research. 

This leads to an increase in interest rates across various forms of corporate debt, making it even more challenging for companies to secure equity financing. To attract investors, companies must demonstrate the strength of their business model and their ability to meet growth expectations. Unless a company possesses solid fundamentals, investors are showing a limited appetite for taking on risks.

Trending: Elon Musk and Henry Ford revolutionized the auto industry. This startup is doing the same for housing and all you need is $250 to become an early investor.

Lackluster Performance Of Newly Public Companies

Markets turned upbeat after several high-profile IPOs were completed last month, signaling a revival of the initial public offerings markets after nearly 18 months of dormancy, as the global economy heads toward recovery. 

But continued market headwinds, including rising interest rates, concerns regarding a looming government shutdown and lingering geopolitical tensions, have caused investors to maintain a risk-averse stance. 

"People bought the stock [Arm and Instacart]. Some people instantly turn around and sell the stock for whatever profits they can get after a day or two," Chase Investment Counsel President Peter Tuz said. 

Short interest in Arm has been increasing, as reported by data and analytics company Ortex. Approximately 8.83 million shares were on loan as of Sept. 20, equivalent to around 5% of the stock's free float. Rising short interest typically has a bearish connotation, as short sellers expect the stock price to decline in the near term.

Many venture capital firms, including Fundrise Venture Capital, have been capitalizing on market weakness to scoop up promising tech stocks at a cheaper price. Investors who are betting on the tech sector's revival can get an equity stake in Fundrise's Venture Capital Fund with just $10. 

Lower Funding Availability 

Even high-profile listings have failed to live up to the hype, as shares of recently listed companies have closed well below their IPO price within just a few days. 

According to KPMG International Ltd., companies that went public this year have secured slightly more than $18 billion in funding — a decrease compared to the approximately $23 billion raised in 2022. 

It's also a significant drop from the $300 billion raised in 2021, which marked a record-breaking year for IPOs. Although IPO fundraising has seen a gradual improvement since the fourth quarter of 2022, it still falls far short of its peak. 

The decline can largely be attributed to persistently high-interest rates and the overall financial climate, with the Federal Reserve's efforts to combat inflation keeping rates elevated.

"We're in an IPO market that's not fully open yet. We're in rebuilding mode," said Douglas Adams, global co-head of equity capital markets at Citigroup. "Rebuilding modes generally aren't a straight line."

See more on startup investing from Benzinga:

• Airbnb was worth $47 billion at IPO. This Startup Is Automating The Trillion-Dollar Hospitality Market. AI Startup Looks To Put Airbnb Hosting And Property Management On Autopilot
• Warren Buffett once said, "If you don't find a way to make money while you sleep, you will work until you die." Here's how to collect $1,000 per month from Buffett's favorite dividend stock.