Why Go the IPO Route?
My blog post from early October – “Why Are There So Many Unicorns with Sky-High Valuations?” – generated some reactions and questions.
One of the reasons I wrote the blog post was the proliferation of SPACs providing unicorns with IPO exits. But after all the IPO hoopla died down, many of those unicorns did not have strong quarterly sales and solid earnings reports after being rushed into their public offerings by VCs and late-stage investors.
I was also intrigued, however, by a question I received from a business school student who asked, “When do you first plan to go public?” The short answer is at startup or when the company is founded. But there is, of course, a longer answer.
First, let’s understand the main reason for conducting an IPO. Why do companies go public? The answer, fundamentally, is two-fold. The first driver is to provide liquidity to existing investors. The second is to generate a way to fuel growth. But additionally, and more specifically …
An IPO provides an early exit for vested founders and employees.
Companies want access to more funds from a larger pool of capital. Public companies have that access, and with it, and can secure it to drive future growth. Pre-IPO companies, on the other hand, are generally constrained to funding obtained from angel investors, VCs and PE firms.
Going public gives a company “credibility value". (hat tip to Bob Mason, co-founder and managing director of Argon Ventures for this reference). One public company CEO told me that it is so much easier, for example, to recruit the best talent after an IPO, as compared to trying to do so at a pre-IPO company. A board member at a material science company told me that being public makes it easier to order raw materials during these challenging times of shortages of supply chain interruptions. Securing raw materials is often more difficult for smaller, privately held companies, and sometimes these companies simply cannot secure the materials they need.
Being public is helpful in building customer relationships with large corporations and Global 2000 companies.
Being a public company brings greater transparency into corporate financials, and more openness regarding all types of strategy and business models and methods.
For founders and early employees, going public is realizing value for their “sweat equity” or “taking money off the table” as a hedge or reducing risk in their personal portfolios.
Many VC-based startup companies have already, in effect, gone public. Unicorns have raised hundreds of millions of dollars and are recognized leaders in their industry of business segment. They also maintain high public profiles in the media and are closely followed by industry experts as well as main street. With the exception of regulatory reporting requirements, yet with lots of scrutiny from all other angles, these companies, in nearly all aspects, already are ‘public’.
Besides those might-as-well-be-public enterprises, there are degrees of going public. For companies that have not done an IPO, early VCs can exit by selling their stock in those companies into secondary markets.
One former CEO of a public company, who resides in Palo Alto today but started his venture career in the Boston area, said recently “After the IPO, I knew the company is properly capitalized. When I worked in startups, I knew the company was continuously under-capitalized. It was like operating with a sword perpetually hanging over my head.”
I asked Rich Tong, co-founder of two tech startups, two non-profits, and co-founder of Ignition Ventures, why startups go public. Here’s his response.
“There is great liquidity in private markets — more than ever, in fact — which allows companies to stay private much longer. But if a company has a track record and a leading position in its market, then going public lets early investors exit without impacting that company’s long-term value.”
Andy Feinberg, co-founder and managing director of Argon Ventures, says:
“There is a tendency for ambitious founders and investors to sometimes rush to a ‘flashy’ outcome. They forget the really expensive obligations that accompany an IPO. In my case, at Brightcove, it really forced us to think about the concrete reasons for going public versus those costs.”
One of those obligations – and it’s a big one – is quarterly reporting and managing Wall Street’s expectations. It’s also true that many public technology companies become the target of law suits and other onerous regulatory inquiries and legal nuisances.
For most of those involved, an IPO shouldn’t be viewed as an ending, but rather, as more of the beginning of a long and challenging journey.
As one investment banker (who chose to remain anonymous) put it: “Remember, just because you CAN go public doesn’t mean that you SHOULD.”
So, circling back to that B-school student and her interesting question about when do you first plan to go public? The answer is that those involved should periodically evaluate the readiness of the company and how to get there. Ultimately, answering the question of when to start planning for an IPO depends on the wants, needs, and requirements of those involved, and when it looks like the prerequisites for an IPO are in place, and that an IPO will be the best way to deliver an outcome that ticks all the boxes. First, the prerequisites: does the company have the wherewithal to successfully complete an initial public offering? Does the company’s leadership team want an exit to satisfy vested founders, employees, and investors? Can that same team live with the greater transparency requirements and costs of an IPO? Then on to the need side of the equation: does the company need more funds to drive future growth; does it need an infusion of “credibility value"?
Given the mindset and circumstances of most entrepreneurs, the answer to the need questions most often will be yes. That makes ‘Now!” the likely answer to the ‘when to start planning an IPO’ question.