Already, IPO investors have been getting burned. Prominent IPOs from recent years such as Twitter (TWTR), Lending Club (LC), and Box (BOX) are all down over 35% since they made their debut on the public market. The Renaissance IPO ETF (IPO) is down 7.5% so far this year, while the S&P 500 has been flat.

Most investors are unaware of how VCs use public markets to rake in huge pay days while also shifting risk out of their portfolios onto unsuspecting IPO investors.

Photo Credit Anthony Quintano (Flickr)

Late-stage VCs increasingly build onerous provisions into funding deals that guarantee them big returns in an IPO. In the most recent funding round for mobile payments company Square, investors were guaranteed at least a 20% return in an IPO. If the price comes in below that, these VCs will get extra shares, diluting all the other investors.

These structured deals help fuel the bubble in private tech companies. Startups get cash so they can keep marketing like crazy, VCs get guaranteed payouts, and everyone gets the prestige and attention of being a “unicorn”. So who suffers? IPO investors that are tricked into believing these massive valuations have any basis in reality.

Bad IPO Pipeline Is Swelling

It’s getting harder and harder to find people that disagree with the notion that a startup bubble is forming. Even influential venture capitalists are warning of inflated valuations.

“Our late-stage, privately held technology market is clearly in a bubble,” wrote Upfront Ventures general partner Mark Suster on his blog last month.

The list of startup “unicorns”, privately held companies valued at $1 billion or more, has grown rapidly and now stands at 143.

“When we start throwing around the billion dollar valuation number in such a casual way, then it is a sign we are losing some perspective,” said Joe Horowitz, managing partner at Jafco Ventures. “Building a company that is truly worth a billion dollars or more takes a lot of work and lot of smart people.”