In the old days, every entrepreneur planned on taking their startup public, and making it big. Today the rate of startups going public (IPO – Initial Public Offering) is finally up from the dead zone of the last two decades, and is now double the rate back in 1999. Smart entrepreneurs are now starting to look at this option again, as well as the challenges of running a public company.
Last year was quite a year for IPOs, largely influenced by the significant rise in the number of special purpose acquisition companies (SPACs) who went public, despite almost uniformly negative returns. Thus, today around 90 percent of successful startups are still acquired by bigger companies versus an IPO, as the safer and preferred method of growth and funding.
The reasons are a lot more complex than the meltdown of key investment banks in the US a few years ago, so don’t expect any real change in the numbers soon, especially with recent stock market downturns. In my view, the key reasons that IPOs have lost their luster from an entrepreneur and investor perspective include the following:
- The US IPO process has stumbled badly. Too many startups have experienced early financial losses and technical glitches, like Uber and the Zynga IPO a while back, which antagonized individual investors and startup executives as well. In addition, most ordinary investors are convinced that IPO rewards only go to insiders.
- Going public is an expensive process. Typical costs for startups today range from $250,000 to $1 million, even if the offering does not go through. In addition, huge amounts of executive time are required, as well as hits to key operational, accounting, and communication processes. The M&A alternative looks simple by comparison.
- Constant pressure to increase earnings. Because public shareholders usually take the short-term view, they want to see constant rises in the stock's price so they can sell their shares for a profit. Thus, there is tremendous pressure to increase current earnings, and little appetite for strategic investments.
- Startups going public are laid open to competitors and critics. Startups are typically run by a couple of executives who are reluctant to disclose via the prospectus and SEC reports all the decision-making criteria, operational financial details, and compensation formulas. With thousands of shareholders, dealing with critics is an onerous challenge.
- Complying with Sarbanes-Oxley requirements is a heavy burden. Public companies of any size must comply immediately with the full reporting requirements of the SEC. There is no accommodation for smaller public companies, who can’t be competitive in their space with the new accounting, documenting, and reporting processes required.
- Public companies are always at risk for takeovers. Friendly or hostile takeover attempts are just a couple of the many ways that company founders sense a loss of control of their own destiny. The board of directors, as well as public stockholders, are no longer part of the inside team focused on the founder’s vision to change the world.
- Increased liability risk exposure. Public company executives and directors are at civil and even criminal risk for false or misleading statements in the registration statement. In addition, officers may face liability for misrepresentations in public communications and SEC reports. Executives are also at risk for insider trading and employment practices.
- Violent market swings usually hit public companies first. Private companies in less-relevant market segments can often fly under the radar in turbulent times like the recent recession. Public stockholders are more easily swayed by emotion and the activities of the crowd, than real market conditions.
- Startup founders don’t fit in a public company. Most just don’t enjoy all the challenges of communicating to analysts, placating demanding stockholders, and keeping up with legal reporting requirement. They know they can be quickly tossed aside for not maintaining the right image and the right relationships with people they don’t like.
- The image of large public companies is negative. In the last few decades, the paternal image of large multi-national company leaders like Thomas Watson at IBM and Henry Ford is gone. Now the mistakes of large companies like Enron and BP have set a new image of public companies as being led by greedy and uncaring executives.
These negatives have largely overshadowed the potential IPO positives of increased capital for the startup, possible huge increase in personal net worth, broader access to investors, market for their stock, the ability to attract top-notch professionals, and the peer prestige of running a public company.
Thus most startups I know don’t even mention the IPO exit option, when applying for angel funding, and most angel investors will react negatively if you do mention it. As best, you should reserve this option for later stage VC discussions, once you have a well-proven business model, large market following, and substantial revenue.
More importantly, make sure first that you really want to give up the entrepreneur lifestyle for the challenges of a public company executive. I’m betting that Mark Zuckerberg of Facebook fame still has second thoughts from time to time, with all the political scrutiny, despite being worth over $70 billion as a result.
Marty Zwilling
via https://www.AiUpNow.com
May 29, 2022 at 10:11AM by MartinZwilling, Khareem Sudlow
