IPOs Just Aren't What They Used To Be

I spent the day yesterday with VCs from other firms. I heard two stories about IPOs that are worth sharing.

One VC told me a story about a failed IPO for one of their portfolio companies a few years ago. He told me the legal and accounting bill they got after the IPO was pulled was $3.5mm. Yup, $3.5mm for an offering that was not successful.

The second story has a happier ending. It was about an IPO of a company that happened recently. The company was able to get public. It has revenues of almost $100mm a year and is profitable. The company raised about $75mm in the offering. And it is now trading at a market cap of around $300mm. That is a lower valuation than the company would be able to get in a late stage private financing in my opinion.

Taken together, these stories tell a sad tale about the IPO market. First, it is way too expensive to go public. And if you don't get your offering done, which is not an unusual occurrence, you are left with a huge bill to pay (and no cash to pay it with). And if you get your offering done, your company will likely be valued lower than it would be valued in a late stage private financing.

I used to think that the IPO was the ultimate exit for a venture backed company. Then in the late 90s, I was involved about a dozen IPOs, sat on some public boards, got sued by ambulance chasers, and saw the vast majority of our IPOs underperform and get abandoned by wall street. Since that experience, I've become very wary of the IPO exit.

I believe that the IPO exit is appropriate for only the very best companies, maybe one or two companies per fund, which would be the top 5 or 10 percent of our portfolio. For every other company, I think liquidity offerings followed by an eventual sale transaction is the best outcome. The cost is just too high and the benefits are just too low for most companies these days.

#VC & Technology

Comments (Archived):

  1. Julien

    You mentionned that the “successful” IPO would have probably been a better deal if it had turned into a PE deal. Why would that be too late?Also, why would internet businesses not be good candidates for regular private equity funds? They are mostly “consumer” and, when the business is proven they are real cash machines, with very high margins. I would expect that to be the definition of a LBO candidate.

    1. fredwilson

      i think the PE guys are starting to look closely at VC portfolios for targets

  2. Rick Bullotta

    Let’s not forget that in the Sarbanes-Oxley era, it is not only expensive to *go* public, it is also expensive to *stay* public, along with the often not-so-desirable side effects that SEC disclosure requirements force upon a company as well. There are a great many reasons not to do an IPO…

    1. Dan Lewis

      To some degree — and I’m no fan of SarbOx — this is a good thing, though. It’d bad for public markets to be funding large scale venture rounds, as demonstrated by the pre-2000 market crash. The side effect of the ongoing Sabanes-Oxley costs is that it’s harder for a company with speculative revenue streams to be public, so they don’t IPO.(Not that they really could anyway.)

    2. Fred T

      SOX can be very demanding sometimes. Honestly, it is not very cost-effective to a certain extent. Although it does ascertain public companies perform according to SEC’s standards, the amount of hours spent, unique processes implemented relative to each company, and office resources are not being used optimally.I meet a lot of miserable CPA’s working 24/7 lately.

  3. Kevin

    When you say a “liquidity offering” what do you mean? Who is the buyer of the shares in such a situation and does the original investment group get out 100%?I am curious if you think it is such a bad thing that IPO’s aren’t the obvious out anymore? It seems to me that it may be a good thing, on the whole, that companies aren’t all racing to be public (assuming there is an acceptable alternative for the founders and investors).

    1. fredwilson

      the buyer of the shares is usually an institutional entity (a late stage VC fund, a hedge fund, a sovereign wealth fund, etc)usually nobody sells 100%and i think it is just fine that IPOs aren’t the obvious exiti should have said that

  4. Dan Lewis

    You say: “I used to think that the IPO was the penultimate exit for a venture backed company.” So what was the ultimate exit, acquisition by a giant?

    1. Mark Essel

      I think you nailed the exit.

    2. Dave Pinsen

      I was wondering the same thing.

      1. Pascal-Emmanuel Gobry


    3. Guest

      He obviously used penultimate because it sounded cool.

    4. JLM

      Penultimate — going public thereby creating a public stockUltimate — selling the public stock and taking the cheddarThe epitome, the ultimate, the piece de resistance!Or, it could just have sounded cool? LOL

    5. James

      You all realize that penultimate means second to last, right?

      1. Dan Lewis

        Right, or second-best, in this parlance.

    6. fredwilson

      going public and then getting boughtthat’s what Milton Pappas taught me when i first worked in the VC businessbut i changed the word because upon reflection, it is confusing

    7. Steve Thommes

      Going public and then getting bought is certainly the more common successful outcome, but it’s not the ultimate. There are 100 GeoCities, Broadcast.coms, YouTubes and PayPals for every true ultimate outcome: to be one of the select few, enduring companies who’s equity continues to increase and increase substantially in value post-IPO.Companies like Google, Apple, Amazon, Microsoft and Yahoo are members of an elite group that keeps the ecosystem of supply-side, step-function equity valuations and successful harvests sustainable. These are the companies that create something new, build something meaningful and change the world – in addition to positively impacting IRR.

      1. fredwilson

        so truethat is the ultimate outcomebut not the ultimate exit

  5. lvgaldieri

    Rick makes a good point about SarBox. The real question is can these markets be made more efficient, and if they can’t, why does the IPO narrative still captivate entrepreneurs?

    1. Dan Lewis

      Because even with the ineffeciencies, the payout is still as big as it gets. While you can do a sub-$1bn exit to a PE firm, that’ll be hard for larger companies. Not impossible, of course: YouTube went for more than that and Zappos came close.

    2. Lina Inverse

      Didn’t the tradiation VC model with an IPO exit have a good run from the late ’50s (e.g. DEC) to just after the turn of the century? It was certainly the game when I started in the workforce in 1980.If so, it’ll take some time for expectations to adjust to the new reality.

      1. Harry DeMott

        It worked – but the companies going public were not subject to SARBOX, and they were generally a lot larger when they went public – and almost to a company they were already profitable (i.e. net income / EPS positive) when they went public. Wasn’t the case the last time around – and institutions have long memories. One of the reasons Google did so well as a stock – was that it did so well as a business. Tons of FCF, lots of earnings etc… It was already a massive winner when it came to the market. Contrast that to some of the dot com bubble companies when they came to the market – Billions of $ in market cap – not much in revenues or cash flows.

        1. JLM

          SOx is way overrated. It is simply the difference between bridge and hearts. A bit more complicated.There is nothing in SOx that a well run business would find difficulty doing and in this day and age of computerized everything it is the creation of the original documents, models and graphics which is the real burden. Thereafter, fire up your monkeys — monkey see, monkey do.SOx cannot make a crook honest and thus if fails on the most elemental of human conditions — honest folks are going to operate honestly and crooks are not going to be swayed by paperwork — cause what defines their crookedness is disregarding the rules in the first damn place!

  6. kidmercury

    lol, i love this post boss. it’s almost too good of a setup, i mean there are so many ways i can take this and drop tons of kookological bad news i almost don’t know where to begin.of course when in doubt we start with 9/11 being an inside job. the reason the IPO market sucks is due to (1) tyrannical legislation and (2) a weak economy directing too many resources to economically negative activities like war. those who want to see a stronger IPO market should address the problem, or simply stop complaining and bow their heads in defeat and accept the tyranny that has been placed upon them.the stock market is a rigged casino and the may 6 flash crash was not an isolated event due to fat fingers or similarly ridiculous explanations. if you are a CEO of a company with an opportunity to go public, do you really want to expose your company to this type of a casino?remember what US congressman brad sherman said on the house floor regarding how if the bailouts were not passed the banks would tank the stock market. below is the URL to the video:http ://www.youtube. com/watch?v= HaG9d_4zij8do you want your company to trade in this type of environment? do you think it is responsible to stakeholders to put your company in this type of environment?M&A will become harder as well as the american finance industry continues its inevitable collapse. the collapse is inevitable because american finance is driven by credit, a by-product of the fact that all money is lent into existence.the solution is reform — either through legislative reform through the existing system (extremely unlikely IMHO because of how broken the political system in the US is) or alternatively to build a new financial industry, starting with money supply, as sound money is the foundation of investing and finance. if people are unwilling to build a new system and/or reform the existing one, they will have to deal with the consequences of their ignorance and political apathy. and worst of all, they are likely to have kid mercury mock such behavior and rub the truth in their face. damn.

    1. Mark Essel

      You and Shirky agree.The ‘and them some’ is what causes the trouble. Complex societies collapse because, when some stress comes, those societies have become too inflexible to respond. In retrospect, this can seem mystifying. Why didn’t these societies just re-tool in less complex ways? The answer Tainter gives is the simplest one: When societies fail to respond to reduced circumstances through orderly downsizing, it isn’t because they don’t want to, it’s because they can’t.

      1. kidmercury

        great quote you dropped, i agree 100%. there is a guy named john robb, former US military guy and entrepreneur, who writes a blog on the collapse of complex systems. he also wrote a book, brave new war, that goes into more detail about the collapse of complex systems, with a focus on how terrorist networks are launching low-cost initiative to disrupt complex militaries — how the terrorist networks are too nimble to catch, and how the militaries have costly systems that are very vulnerable to low-cost attacks. i found it to be such a useful analogy when thinking about how spammers and hackers can take down centralized systems, and how federation can be a better defense as it allows complexity to be distributed, IMHO.anyway, i just wanted to mention john robb as i think you may like his stuff if you are not familiar with it already.

        1. Mark Essel

          Thanks I’ll certainly look him up.That complexity leading to failed systems thing is so true in software.

        2. Harry DeMott

          Like it thanks for the tip.

        3. JLM

          The discussion you have initiated is a very interesting discussion and one that the military is grappling with on a daily basis. Very successfully in my opinion.You are not giving the military enough credit for how successful they have been in this evolutionary process.Withess the first Gulf War which was a traditional WWII style battle of armor and armies moving forward in a straight line with flanks covered. US tanks could acquire infra red targets at 3000 meters and hit them about 95% of the time while Iraqi (Russian) tanks could only acquire optical targets at 1-1500 meters and hit them about 40% of the time.Better targeting, longer firing distances, better gunnery — better outcomes. Papa Johns! (oops, sorry, got off track for a second.) Nonetheless the “last” war rather than the next war.Striker Battalions, drones, Special Forces, pinpoint munitions, cyber warfare, eavesdropping, incredible space based observation targeting on individual shitheads identified by sound, sight, smell, movement, cyber footprint and being in the wrong place at the wrong time.A very discrete example — the ability of drone based observation to identify, target and execute donkeys carrying shitheads while on station for 60 hours and being able to film the kill while not risking a single American life. Pretty awesome and nimble deployment of technology.BTW, this is simply Nintendo/Play Station skills deployed in a different arena. Judge, jury, executioner, videographer. Another — the creation of special operations as a career choice — a full and equal branch like the Infantry, Artillery, Armor, Combat Engineers — rather than as a 1-3 year “detail” from another branch thereby getting the very best officers and NCOs to be able to develop a very high level of expertise.The cyber warfare/tech capabilities of being able to identify enemy transmissions via cell phone, to read the enemy’s internet commo, the ability to see the enemy movement from space and the ability to use GPS identification as the basis for immediate targeting creates an enormously nimble means of dealing with very small enemy formations which in a more traditional war fighting context woudl have simply been overlooked.Funny thing — you know who pushed the military in this direction? Donald Rumsfeld

          1. andyidsinga

            Ender’s Game …

          2. JLM

            As a Battle School grad myself, I know just what you mean.

          3. ShanaC

            speaker for the dead -the important closing point

        4. jchewitt

          Kid, you might also like Kevin Carson’s books.The Homebrew Industrial Revolution – his most recent one – is particularly good.http://homebrewindustrialre…Note: I don’t fully endorse some of his opinions on economics, and I think he’s overly-focused on differentiating himself from the Austrian school. But otherwise, he’s a fantastic observer of screwed up corporate practices with reference to free market philosophy.

          1. kidmercury

            wow, thanks for the link, that looks really interesting. i’m going to spend some time going through it.

          2. jchewitt

            You’ll love it. It’s an extremely practical and timely work.His earlier book is extremely dense, but there are some great nuggets there.Walter Block criticized him for giving lip service to the labor theory of value, but I think his position on it is actually a bit more nuanced (and extremely over-complicated).

    2. Fred T

      and thus another wave of economic recession is at large.

      1. JLM

        The first wave has not yet crested and there is a huge set looming beyond it. Looks like the water is going to be contaminated by oil — spilled, drilled and otherwise — for a long time.The Euro Union fails — hell, did anybody really think that the Germans could play nice for a century — and it all ends up being one great dominating country on each continent/large land mass area.US, Germany, Russia, coastal China, Brazil, India. Africa is a mystery.N America gets the best long term prospects — Mexico, Canada, US.US still picks up the free world’s dinner tab on defense.

        1. Dave Pinsen

          “US still picks up the free world’s dinner tab on defense.”Well, we do always seem to pick the most expensive restaurants.

          1. JLM

            Worse yet, our guests never, ever, ever reciprocate — or for that matter “put out”. Sorry.

          2. Dave Pinsen

            I don’t know about that. Australia has sent troops to all of our major wars in the last hundred years or so, even the unpopular ones such as Vietnam and Iraq. Britain passed on Vietnam, but isn’t far behind. Canada passed on Vietnam and Iraq, but has done a lot of hard fighting in our seemingly endless war in Afghanistan.Although our armed forces do some things most of the rest of the world should be grateful for (policing the sea lanes, keeping the peace in East Asia, responding to humanitarian disasters), we also engage in adventures most of the rest of the world isn’t too keen on. It’s understandable if they wouldn’t want to pick up the tab for those.We also do what we do in just about the most expensive manner possible, e.g., paying privates probably six figures in total comp to trade mortar rounds with cave dwellers.

          3. JLM

            Not to pick an argument, but doesn’t the very paucity of your examples prove up my statement?The UN — the supposed mortar which was to making fashioning a common defense possible — has proven a very, very, very expensive private dining club where even there, we pick up quite a bit of the tab to say nothing of the physical inconvenience of having so many “diplomats” loose in our country.It is really the American triple threat nuclear deterrent (ICBM, airborne and sea launch nukes) which is the most costly defense insurance policy. These other countries are hardly even making a dent in the deductible.You would think some country in the area would pick up the Somali pirates issue — hey, Uncle Sam, we got this one!The cost aspect is a tough one because we often settle the tab with American blood.

          4. Dave Pinsen

            My list of examples wasn’t meant to be exhaustive.I’m sure the restaurants and other businesses in New York appreciate the “inconvenience” of hosting the world’s diplomats.Our nuclear deterrent is mainly to deter anyone from nuking us. Sure, it covers our Nato allies as well, but France and Britain have their own independent deterrents, and I think we’d rather cover Germany and other Nato allies with our nukes than have them build their own arsenals.Our navy isn’t the only one interdicting Somali pirates.Other countries are shedding blood as well in Afghanistan today, despite their peoples’ reservations about being involved there.

          5. JLM

            One could barely fill a thimble with the blood and treasure contributed by others to the world’s safety while swimming in oceans of American blood and treasure. It is not even close.

          6. JLM

            North America, NATO, SEATO, Australia, S Korea, Antarctica, piracy, the sea lanes, the skies, outer space — hmmm, I think we’ve got it covered.

          7. Dave Pinsen

            Really, Jeff? Pick a war where we were fighting for “the world’s safety” and let’s see who shed more blood. Let’s try the World War I (if that qualifies as a war for “the world’s safety” and not just a giant clusterf*ck that set the stage for WWII) — could you fill “a thimble” with the blood spilled by our allies the French or British? How about World War II, where our erstwhile allies the Soviets bore the brunt of the fighting in Europe and suffered about 20 times as many military casualties as we did?

          8. JLM

            You make an excellent point and I agree with you. I did not take into account the “big” wars and I was using a more modern frame of reference. My comment was therefore a bit myopic.I have been a student of the Russian front in WWII because of its enormity, the “maneuver” nature of its combat, the employment of so much armor, the importance of physical barriers (rivers, steppes, poor road network, rail) in the campaigns, the fact that it was so underreported in Western history and the fact that given just a few changes the Germans might have prevailed dramatically changing the course of history.The Germans were also economic warriors seeking to conquer rich natural resource lands (coal, oil, minerals critical to steel making) as a means of fueling their war machine in real time to say nothing of literally capturing food to feed their armies. In that regard, it was quite unique in WWII when compared to the Allies.The Russian front war lasted so long that it had distinct phases which spanned years — so different than the Western front which was essentially three or four campaigns.

        2. kidmercury

          the mystery of africa has a very simple explanation. the continent is saddled with IMF loans; africa spends 40X the amount on debt repayments than it does on healthcare. the global banking industry forces countries into debt as a way of enslaving the population. the same thing is happening in the united states — 39% of income tax collected goes to pay the interest on the national debt.africa is also plagued by HIV. HIV is a race specific bioweapon that targets african americans. there is an aids cure, but the cure is patented and suppressed. the patent number for the aids cure is 5676977.

    3. Druce

      The reason for ‘tyrannical legislation’ is because people try to run ‘rigged’ markets and fraud. I’m not sure ‘reform’ really gets a better functioning market in the long run without better market participants and regulators.Being in the public market has its pitfalls, but being part of a large company just imposes a different set of constraints, and is not necessarily the ideal environment for growth and value creation.Maybe the right question is what’s right for the company – an IPO of a minority stake at a lower valuation than available in a private acquisition may be better in the long run for investors, founders and employees, who can time their own exit.

      1. kidmercury

        IMHO tyrannical legislation is the by-product of unholy alliances between regulators and industry incumbents (i.e. goldman sachs, jp morgan) who then use regulation as a means to block new entrants into the market. i think these private lobbying groups are what basically ensure government gets larger and larger, and more corrupted by special interests rather than remaining virtuous.

  7. Harry DeMott

    Many companies these days are bad public market candidates for the same reason that many of them are easy and cheap to start-up. Public market investors want to see the “winners” in their space – and in the past the “winners” generally had the field to themselves for some period of time – now almost no company has a moat – so the public market is way to risk adverse to try and sort out the winners. Liquidity is also a watchword these days – and in the small cap market – liquidity has largely dried up – which is another reason people shy away from the smaller $75M IPO. In that case even if you were Fidelity and got allocated 10% of the deal – you are going to own that forever – just try and get out. I know Fred has been a big proponent of a secondary market for shares – I have some ideas there – and this would be a helpful step in liquidity for investors at later stages. AS long as the SEC is involved – there’s never going to be much of a break in the fees for small companies. Professional fees and SEC fees are almost criminal in their scope (try asking Deloitte to take their fee in shares on an IPO!) but they are a fact of life. Better to start-up a company and take it public with little to no revenue but meteoric growth (Twitter comes to mind) – where investors can dream the dream – or build companies that can last on thier own cash flow – and simply dividend out the cash to investors above and beyond what is necessary to grow – until you get acquired or the market for risky assets comes back – but I wouldn’t count on that anytime soon – not when the best performing asset class out there is gold!

    1. Pascal-Emmanuel Gobry

      I disagree that companies don’t have moats. The way the internet works creates many, many opportunities for strong moats, in particular data assets and network effects.Google has such an enormous data asset, which is their true moat. Even if you were to come up with a “better” page-ranking algorithm than Google, you still couldn’t do anything with it because Google has so much data about what people search for that nobody else has that allows them to refine their product to ways nobody else can. Which is why Microsoft is so gung-ho on buying marketshare for Bing. People mock them for paying through the nose for a half-point here and a half-point there via toolbars and what have you, but they’re not doing it because they think they’ll make it back through ads. They’re doing it because they realize they need a lot more data to be competitive with Google.E-commerce companies like Amazon, Gilt Groupe, Diapers.com, Chegg and others have amazing moats coming from the enormous expertise it requires to run an efficient e-commerce site. “Pick, pack and ship” is an impossibly complex thing to do and even if you could (somehow) find a way to sell books cheaper than Amazon or dresses cheaper than Gilt you just couldn’t do it at scale.Network effects obviously create very strong moats. This is what has made Microsoft the most profitable large company in history. And on the internet, it’s what makes eBay a very profitable and strong company despite the fact that their product has been broken for ten years, and it’s what makes Facebook basically unassailable.Don’t get me wrong: there are plenty of opportunities for disruption on the internet, otherwise I wouldn’t be active in the early stage. But it’s just not true that you can’t build a business with strong, durable moats on the internet.

      1. Harry DeMott

        Either you didn’t understand my point – or I didn’t make it clear – probably the latter (or at least that is what my wife keeps telling me!)Network effects can indeed create some of the widest and most unbridgeable moats. And you certainly have picked up on quite a few of them.However, if you look at your list – almost all of them were started a long time ago – or in the Web 1.0 phase – for lack of a better moniker.In addition, almost all of these were ultimately “fat” start-ups – in that they consumer a great deal of cash to get to the market leading position they are in today.There are always obvious exceptions, but many of these companies would cost an enormous amount to replicate – just as many winners of the old economy would – which is why you don’t see to many competitors to them.Amazingly, you mentioned a few e-commerce sites here. I would argue that Amazon could put Chegg out of business in a year if it really wanted to – but due to channel conflicts – it might not want to go there. Zappos might be a better example – where the culture of the company grew so strong with the users – that Amazon could NOT put it out of business – and bought it instead.To be clear – I agree with your premise – but would caveat it with the notion that given the cost of technology today – and the fast followers that come at any successful consumer facing company – the odds of building up a business and building a sufficient moat around it so that you can achieve $10M plus per year in cash flow or $100M in revenues – and show it growing (which is probably about the lower limit of what is possible in the IPO market today, is extremely difficult.Look at some of the clear winners these days: Facebook – has taken in a few $100M in funding. Pandora has taken in over $100M in funding. Groupon has taken in a lot of $ – although I would argue that they have absolutely no moat – and it is very unclear to me whether or not they will ultimately be a winner in that space.There’s lots of money thrown at a lot of sectors – and a winner may emerge – but you never know who it is going to be. A few years ago, everyone was hot for internet video. Youtube won – and everyone else essentially lost all their $.In location today, who knows whether Foursquare or Gowalla or Facebook or some other service that plays off of them is going to be the winner – yet a ton of $ and attention is chasing this sector.If you are looking for returns in these sorts of businesses – I think getting in very early (low $ price) and getting maximum exposure is absolutely key – because you are going to need fast consumer adoption, and a level of hype around the space to get someone strategic to purchase the asset. Once you are beyond this phase – you had better have built that moat – because the next step is going to be a valuation and or exit based around solid business fundamentals – and you will either be self sustaining (the best of all worlds because all choices are open to you) or you will have to take later stage or public money for growth – or sell to a strategic on the financial merits – and not the promise.All of that is getting tougher.So very long winded way of saying – I agree with you completely – but I believe it is getting harder and harder to emerge as a business with a strong, durable moat.

        1. Pascal-Emmanuel Gobry

          Thanks for your reply.I think it’s hard to build a business with a strong, durable moat in any sector.Re: Amazon/Chegg, I rarely buy the “(Insert Big Incumbent) can crush (Startup) any time” argument. If that were true, we would still be using IBM mainframes running OS/2 to get on IBMNet.Re: online video, location based services, etc., yes, there were/are few winners and many losers. So what? That’s what being a startup (and capitalism) is all about. Doesn’t mean the winners can’t go public. Many losers in social networking, and yet Facebook and LinkedIn will go public and maybe Ning as well.PEG

          1. Harry DeMott

            Agreed.The winners can go public.And agreed – it is very hard to build a strong durable moat, and incumbents can be disrupted (I love the Clayton Chrstensen’s books on the subject – Innovators Dilemma and Innovators Solution)But perhaps these are the points of Fred’s initial post. IPO’s aren’t what they used to be – which was the last round of venture funding – or in the late 90’s, perhaps the penultimate and ultimate rounds of financing. IPO’s are now what they really used to be – growth capital for proven winners. With so few proven winners – and with the moats – even where they exist – thinner than they have been in the past – the IPO as exit for the VC is just not a viable alternative for many of the companies that get funded.

          2. ShanaC

            The larger question- how do you get to moat knowing that there are mines of information out there?IPO’s are definitely not what they used to be- the end model of VC is moving closer to PE, and how do we adapt?And after reading what you and PEG wrote- why isn’t accounting and law being disrupted at all? It’s an overly ripe area, considering their biggest customers have shrunken in amount. (even if the individual bank sizes have gotten larger)

          3. Harry DeMott

            Funny, we outsource almost everything, but accounting and law are two things that never seem to make it offshore. Apple designs beautiful products from its home in Cupertino and they are made in a factory so grueling that people jump off the roof just to get out of it. I’m betting their patent lawyers make more than $2 per hour and are located in the US. Their accountants certainly are. Tough to outsource those who make the rules. Do you realize that in the S&P 500, I believe there is only 1 company not audited by the big 4 accounting firms (and there may be none). Does this make sense? Is it really that hard to add up the numbers? Yet it is always seen as suspicious if you don’t have one of the big guys on your side. It’s like the ratings agencies. Moody’s and S&P have shown themselves to be completely incompetent – and everyone in the markets know they are a joke – yet try doing a bond deal without one of them – you can’t.

          4. ShanaC

            As I said- knowing all of this- why are certain areas so hard to disrupt? Lexisnexis/westlaw_ that’s it- those guys are ancient!And you may not need to outsource to cut costs.

          5. Harry DeMott

            there has been some disruption in the legal world – look at legaldocs.com or even better legalzoom.com. Take a look at all the venture hack stuff around start up docs – term sheets etc… It is happening, but I think for the most part there is a level of mystery when it comes to lawyers and the law – they speak in a different language – like doctors – and in general the stuff they deal with is too important to take a chance outsourcing it. It’s kind of like the old saying – no one ever got fired for buying IBM. No one ever got fired hiring Sullivan and Cromwell in the corporate world – or Wilson Sonsini in the venture world – they are just viewed as having the contacts – so act almost as a business partner. Hard to outsource those – as compared to a manufacturer. So to some extent – you can outsource the manufacturing part of the legal profession – just as you can outsource the manufacturing part of the accounting profession (sorting through the numbers) but when it comes time to sign the docs or bless the audit – you are going to probably have to deal with a local and expensive firm to get the job done.

          6. ShanaC

            I think that internal to the law world or the accounting world, what you cando is cause firms to network more closely together. The contacts and someof the more complex writing become much more commoditized from a law firmpov. However I also realized that after a certain point making such asystem is really difficult because of the way law in the US works. Non-disclosure and you can’t reveal certain sorts of information to othercounsel, even if they are on your side. After you create certain kinds of basic documents, nothing is standard. One of the reasons legalzoom works well is that most cases won’t go to courand that the basic document when it does go- seems to work. However, aftersome point, there is a need for airtight work and for customization- or whatto do on top of the boilerplate for interesting side cases. And there is alarge need to talk to each other about certain rulings and tofurther their networks. this is after talking to people in boutiques,biglaw, and seeing legalzoom et al. Lawyers don’t like talking about itbecause they don’t like having their gossip disclosed.And, legalzoom et al don’t solve issues with litigation work, justtransactional. Different world both pre, during, and post when it comes todocument development and usage. Also really hard to work through.Also, for the record, certain kinds of doc review are sent overseas.(This is what happens when you have an ex who is a lawyer, a few friends whoare lawyers/going into law, and ask a ton of questions, I always thought itwould be a killer area to do a startup in, because once you get to mvp, youactually could redistill parts of what you did down and use it for otherprofessions where there is a need for the network of the profession to talk about what it does and have in place boilerplate methodologies, such asmedicine and accounting.)

          7. Pascal-Emmanuel Gobry

            “IPO’s aren’t what they used to be – which was the last round of venture funding (…) IPO’s are now what they really used to be – growth capital for proven winners.”You’re right that that’s how it is. I just happen to think it’s a disgrace.PEG

          8. Harry DeMott

            It’s really just cyclical in nature. Post the dotcom bust where they S&P 500 dropped over 50% in 2000 to 2001 people were so shell shocked that they just pulled money from any fund that invested in these areas – which is why to some degree a lot of companies that started then have done well – they just had no funded competition and those that scaled survived to get bigger. Google is a perfect example of that in the extreme. Once you got past that – and the memory of it we had a accounting stock scandal in 2002, a buying frenzy in junk companies in 2003 – and then a speculative debt wave in 06, 07 and on into the early part of 08 when it all came crashing down. Professional money managers have looked at the last year or so and made venture like returns – or better – buy buying first lien bank debt – so it comes as no surprise that venture backed IPO’s – probably the riskiest equities you are going to find these days are not being purchased. The venture IPO market will come back – but only after we get rid of the turmoil in the market – clean up Europe – finally try and figure out what the operating rules are in the U.S. – if everything has not been nationalized – and then, when you have a calm and low yielding debt market (not an artificially low yielding debt market driven by government intervention) will you get people back in the pool. individual investors might be dumb, but as a group – they generally are not completely ignorant. So I don’t view the lack of venture IPO’s as a disgrace – just a symptom of better perceived opportunities elsewhere.I actually view the lack of venture IPO’s as a good trend. Truthfully, one of the greatest assets you can have as a business is a long time horizon – with your business and with your investors. Without IPO exits – VC’s are forced to build real companies that can stand on their own. When this next crop of IPO’s come along – they will be better companies for having survived the drought.In addition, there are probably more late stage investors these days – who have disintermediated the IPO process. Used to be that founders could never get money out. Now you are seeing cash out deals – and in the private market. So if you’ve built a good company – taken care of the car and house payments – gotten some liquidity for your employees – why rush to the exits?

          9. ShanaC

            You know, Chegg may be a totally different sort of information basisrenting is not buying. No matter the product. There are reasons why someone would prefer to rent over buy…so you would end up with a different dataset.

  8. Ken Andersen

    Fred, the scenario of one or two IPOs per fund is probably a fair description of the reality of the past decade for most VCs but it suggests a pretty significant change to the traditional venture capital return model. Given the number of companies that don’t make it in a portfolio, are one or two IPOs enough to bring in a level of long-term returns most LPs are expecting from venture capital? I assume you’ve laid out your expectations to your LPs and they’re on board but doesn’t this suggest that the industry will shrink in general as this new reality sinks in and many LPs look elsewhere for either higher returns or, at least, less risk?

    1. fredwilson

      Ken – i think you can do fabulously well as a VC in this environment. i don’t want to jinx anything so i won’t tell you what i think our first fund will return, but i think we can put up exceptional returns with only a couple IPOs in the fund.

  9. Mark Essel

    IPOs SHMIPOsSo M&A is king in liquidity.What do you do when you own a bunch of shares of a super successful business that doesn’t want or need to become liquid? It may not have started that way, but it can become so. You have a 10year horizon for the fund, and the good ole fiduciary responsibility to your LPs. What’s the right thing to do for all involved parties? Holding on to private shares really isn’t a great option.

    1. Dan Lewis

      I’ve wanted to know the answer to this as well.

    2. JLM

      Interestingly enough, I suspect that as the tax rate changes on capital gains, there will be more thoughtful, innovative and focused uses of debt as a means of creating liquid wealth while avoiding tangoing w/ the tax man.This has been the norm in the real estate business for decades as owners have financed and refinanced to access their growing equity in a non-taxable event. If you then leave it to an heir, they inherit it subject to the stepped up basis thereby slipping past the tax man yet again.Of course, dying is an extreme tax strategy by any measure, no?You own a company or asset subject to debt and borrow against that ownership using the cash flow from the company to repay those debts over time.You own shares in a company subject to your individual basis and you use those shares to borrow against to create liquidity and repay that debt through company performance.You must avoid the taxation — dual taxation — of dividends, if possible but that is simply a structuring issue.Only solid cash flow allows these strategies to be considered.

      1. Mark Essel

        So take out a big loan and pay off your investors. That works although if it’s only 1.5-2X it seems like a raw deal for them.

        1. JLM

          I am seeing it more in the context that a VC distributes the shares to all involved, including himself, and then everyone fends for themselves. This is essentially what happens in a great number of IPOs. One or the other party does not want to cash in at the IPO or more likely has a “tie up” period thereafter.

  10. Henry Blodget

    I think we need a new public market that plays the role that NASDAQ used to–smaller, riskier companies along the line of London’s AIM. This would have far lower reporting and legal requirements. And it would cost far less to list there.Anyone who bought stocks on the market would have to sign a form saying “I understand the extreme risks involved in investing in small companies, and I understand that I might lose my entire investment. Except in cases of outright fraud, I promise not to blame my losses on anyone else.”

    1. Adrian Scott

      Yes, and in the meantime, let’s use the AIM and other int’l markets — that could be the easiest thing for now, especially as we make our startups more international to begin with.

    2. kidmercury

      agreed, but not going to happen without meaningful political reform.

    3. Max Kennerly

      If you’re going public on an international market, you’re not a “small company” by any realistic definition. If you don’t want to shoulder the burden of having public shareholders, don’t go public.

      1. Max Kennerly

        Side note to Fred: Disqus calls me “Esq.” even though my underlying Twitter account (used for the login) does not. Have never figured out how to fix it.

        1. Evan

          My settings –> Public Info –> Display Name

      2. Adrian Scott

        Hi, I don’t understand how you have come to that conclusion. The logic, or assumptions, seem flawed. Please share. Thanks!

    4. Dan Ramsden

      The exchange won’t matter if the buy-side won’t buy the shares, which the buy-side will only do to the extent that (1) the position moves the needle on its $18 gazillion investment pool, and (2) the position can be offloaded into a liquid trading environment.This liquid trading environment being dominated by other gazillion dollar entities and algorithmic platforms, the odds don’t favor small-caps regardless of the exchange.I am exaggerating the point for illustration, I realize the issue is not that extreme. But then, IPOs have not exactly died, so we’re all talking in exaggerations.

    5. Harry DeMott

      I believe you have some history with the SEC. Do you really think they would let individuals think for themselves – and accept the responsibility for their own portfolios? That organization is there to protect the people from itself – so good luck trying to make it easy to generate growth!

      1. William Pietri

        You’re familiar with the Dunning-Kruger effect?http://en.wikipedia.org/wik…It’s one of many pieces of evidence that most people are not very good at thinking for themselves. (Especially so when competing with experts who are likely to rook them, as is the case in financial markets.) If you want to sell something potentially very dangerous to the general public, you have to accept a lot of regulation. It’s true of food, cars, houses, and yes, financial instruments.If you want something different, you’ll have to find a way to restrict participation to actual experts, not just, as Henry Blodget suggests, idiots who can be persuaded to sign yet another piece of paper. Require people to be licensed to participate, and make the licensing requirements tough. We do this with, e.g., explosives and prescription drugs, and it works out fine.

        1. Harry DeMott

          Thanks for the link – interesting reading.It is my belief that most people are not good at thinking for themselves because society has eliminated the need to think to a large degree. And we have excused people from thinking by allowing them to hide behind their own ignorance.We learn by doing.Put your hand on a hot stove at a young age and when you are crying because you have burnt yourself – you rarely go back to the stove again – unless of course you are a complete idiot, or just make a mistake – which we all do.If people lose money in the stock market – it is generally not because someone has ripped them off. It is because that person made a decision to invest in something and it didn’t work out for whatever reason – but to blame everyone else: rigged market, crooked dealer, criminal company, financial charlatans, etc… is to miss the point completely. People lose money because when they invest, they fail to think for themselves – they listen to others and don’t do the work themselves, weighing the risks and rewards for what they are undertaking.This is the argument for why we can’t reform social security – because people are ill equipped to handle their own retirements. And when they see the market go down – they all cry – see what would have happened if we put our social security money in the market – not realizing that the average duration of your social security investment is something like 30 years – and not 3 months. And we excuse the fact that a 6.2% pre tax contribution up to $106.8K is probably not going to generate enough income to last a lifetime of retirement starting at 62 for most people. By outsourcing your thinking to the government you will have impoverished yourself in old age – and unnecessarily burdened your heirs both while you are alive – and long after you are gone.I’m a huge proponent of personal responsibility. You invest and lose – it is real easy to point fingers but to quote Dire Straits “when you point your finger cause your plan fell through, you got 3 more finger pointed back at you.”Making it more difficult to invest – or have people qualify as experts is not the answer – getting people to think for themselves – to ask the right questions – to take responsibilities for their own actions is the right answer.

          1. Adrian Scott

            Excellent points.

          2. gorbachev

            “…to take responsibilities for their own actions is the right answer.”Good luck with that. People will rather watch Oprah and have her think for themselves than actually think.

          3. Donna Brewington White

            “…getting people to think for themselves – to ask the right questions – to take responsibilities for their own actions is the right answer.”So, so true…in general.

    6. William Mougayar

      Isn’t that what Small Cap Stock Exchanges were supposed to provide? Agreed that the barriers to public markets must be lowered to allow a greater number of companies to raise money that way.

    7. fredwilson

      we sort of have that with the secondary market right now

    8. Narayankpl

      Great Idea!!

    9. Carl Wimmer

      I looked at AIM.The reasoning there is that the brokers are the gatekeepers to keep out the undesirable companies.The problem is that the brokers charge 100,000 to 250,000 GBP to “peruse documents”AIM is no solution. The USA has the right idea.Pink sheets are easy, OTC tougher, NASDAQ tougher and so on.

  11. Berislav Lopac

    “First, it is way too expensive to go public.”But how about other markets? It might be expensive to go public in the US (SarbOx and stuff), but would it have any impact if one tried going public in, say, London or Tokyo? Especially if we’re talking about true global companies like most high-tech startups aspire to be?

  12. Dave Pinsen

    I think we need JLM to weigh in here on the pros and cons of going public via the OTC BB (though the amounts of money raised there are probably too low, generally, for one of Fred’s exits).

    1. JLM

      I am just running out to do something honest in the sunshine but I would make the quick observation that what once was considered “small cap” is now really “nano cap” and the nano cap market is to the investment world what the first craft breweries were to Budweiser.Not much.Nano caps will become small caps, God willing, and then the investing public may take some note as their radar screens come alive.This is either a great opportunity or a great liability depending upon your viewpoint.The world can live without ever owning a single nano cap stock and you can’t deploy too much capital in such small market caps.On the other hand, a small investment may become a long ball with men in scoring position and the implications of management expertise and the quality of the idea can have a huge impact on outcomes.A very funny dilemma.

  13. Dan Ramsden

    One of the reasons for the mentioned small-cap IPO underperforming is that small cap stocks have fallen prey to a market inefficiency wherein capital and attention are largely focused on the biggest and most tradable positions. This is only one of many market inefficiencies in an environment dominated by machine trading and hugely concentrated capital pools. The end-result of this market environment, and Fred’s logical conclusion drawn, is that independent companies will be fewer, and consolidating ones will continue to grow. The inefficiency could thus self-perpetuate.

    1. Lina Inverse

      Isn’t this sad state of the small cap market due in large part to many exiting it? Therefore it could self-perpetuate until they return,

      1. Dan Ramsden

        What would be the catalyst?

    2. JLM

      Rather than “market inefficiency”, I think the issue is perhaps properly identified as simple market breadth and depth.How much money can an institutional investor, high net worth investor, mutual fund put into a $100MM market cap stock without triggering SEC reporting levels and without completely compromising future liquidity issues including just being able to take their profit if so lucky?The issue is even more confounding when the ownership of management — a good thang — reduces the float to a level well below the amount of shares actually “issued”.

      1. Dan Ramsden

        I agree, but I consider this to be a form of market inefficiency… when good companies with good products can’t attract capital strictly due to size – not risk, not prospects – but size. In fact, some bigger companies may have lesser growth prospects. In an efficient market, capital should flow to its most optimal uses.

        1. JLM

          Bit of an error of composition, buying and selling the stock of a “good company” does not put any money in the company’s coffers and has no impact on the company’s funding of growth. Lovely little stock chart w/ a pleasant upward leaning share price does not provide any funding to the company at all.On the other hand, a good product and a clear upward bias on operating cash flow would, in a more normal time, provide the narrative for a company to go raise debt financing. This is basic business finance driven by the normal financial ratios.Make a good product, sell it at a profit, pocket some cash, develop the narrative and accelerate the growth by raising a bit of debt. Business finance 101.

          1. Dan Ramsden

            Primary vs secondary shares doesn’t change any part of my argument. Anyway, never mind, we’re talking past each other.

          2. paramendra

            “Make a good product, sell it at a profit, pocket some cash, develop the narrative and accelerate the growth by raising a bit of debt. Business finance 101.”:-)

  14. Robert Alvarez

    “That is a lower valuation than the company would be able to get in a late stage private financing in my opinion.”I’ve worked in both late-stage private as well as small/micro cap public investing. A big input of the valuation thoughts of many late-stage private investors is what the firm will be worth if/when they go public. It may not be explicit in their models, but it is certainly implicit in their thinking and deliberations, and informs what they are willing to pay.Some may not like to hear this, but it may be that the late-stage private market is over-valuing these companies, and needs to adjust downward. To be fair, frothy public markets have certainly inflated private market valuations in the past; now we may just see the process drive the figures in the opposite direction.(Sorry for double post. Stuck it in the wrong comment box at first.)

    1. JLM

      Your comment supported by your actual experience and analysis is obviously correct. Ocham’s Razor?

    2. fredwilson

      great point and you may be rightbut the late stage investors don’t need an IPO market to make moneythey can make money with exits to strategic buyers as long as they are patient and the companies continue to build value

      1. Donna Brewington White

        Does this support the observation that VCs and PEs are growing in similarity?

  15. William Mougayar

    So, in other words, a majority of startups are experimental laboratories for larger companies, and only a few emerge to eventually become large companies on their own.What “was” previously expected in IPO-land was not realistic, and therefore it shouldn’t be surprising that today’s environment is more realistic.I wonder what you (or any reader) think of this recent article “Is Entrepreneurship Just About the Exit?” http://techcrunch.com/2010/06/12/is-entrepreneu… and I realize that VC’s don’t like “lifestyle businesses” which is a dirty word in VC-speak, but maybe that concept can mature if the numbers and dividends are large enough for all shareholders to benefit, but it’s definitely about a different kind of math.

    1. JLM

      Big companies should, as a matter of prudent investment mangement, let others provide as much of the R & D work as possible because the big guys can concentrate on buying the winners and avoid the costs of funding the losers.It is way less costly to just buy the winners while maintaining a small staff and letting someone else fund the losers.

      1. William Mougayar


  16. Blsavini

    Well, how long did everyone truly feel that morphing the country into little more than a nation of money changers was going to hold up?With each passing year, manufacturing and exporting has given way to everyone attempting to grab their share of the same dollar. With each “lowly job” that was outsourced to keep the pennies draining from this dollar, the consumers were left without a means to pump money back into the system.This is NOT post World War 2. The country has gone soft and intrinsic values and ethics need a realignment.

    1. JLM

      I agree with every word that you have written but exactly where is this rant going and what does it have to do w/ the blog?I am not dissing you in any manner as I think we have, in fact, sacrificed a huge economic benefit — good jobs — just because you can export a job to Mexico or China and improve margins. It is not a smart strategy for the long run if we believe that a fully employed citizenry — which may otherwise turn up hungry at the public trough — is a good national strategy.We will become a nation of financiers and landscape companies — because you cannot export landscape maintenance jobs — with the landscape companies all maintaining the estates of the financiers thereby triggering high levels of illegal immigration.But, hey, I could be wrong.

      1. Harry DeMott

        Yes. You are both describing the central problem with capitalism as practiced in the U.S., and why, more and more it doesn’t make sense to have a public company. Public companies have stocks, and those stocks are held by investors and managers – many of whom have stock options. The incentive for managers is to therefore raise profits any way possible – because with growth in cash flow – you get growth in your stock price, generally speaking. As a result – you do things that you wouldn’t have thought when you were the entrepreneur starting the company. Fire a lot of US workers to save $10 per hour so your margins go up 2%? Sure, if you are trying to maximize the share price. The truth of the matter is that most businesses are naturally self limiting in terms of their size – and once you reach that size you should probably stop looking for more, more, more – but the incentives are geared for exactly that – and the consequences of more and in many cases dire – and long lasting.

        1. Evan

          Comparative advantage. Ricardo.

          1. Harry DeMott

            you nailed it.but comparative advantage needs to have a balance of trade for it really to work.if we outsource telephone call centers and manual labor and factory workers because it is cheaper – and you can raise earnings – that makes a lot of senseHowever, you have to then make sure that all of those displaced workers are then repurposed back to tasks and work that can be exported with comparative advantage.The problem the US is in now to some large degree is that these displaced workers have not been retrained and so unemployment remains high – and because we keep outsourcing all sorts of stuff – what we end up with is a serious unbalanced economy – with the “knowledge workers” who work with a comparative advantage in the world (wall street folks, vc’s, engineers, designers etc…) gaining more and more of the spoils – and everyone else falling behind.Add to this a lack of savings – and you have a recipe for the current disaster.Tough to get out.

        2. Yuhong Bao

          Yea, we need to move away from shareholder capitalism and the quarterly earnings game. It is fundamentally flawed.

  17. GlennKelman

    Love this essay, and I agree with everything you write but it’s worth pointing out that management and investors may view an IPO differently just because an IPO is one of the only ways a company can create shareholder liquidity while still being allowed to direct its own growth, strategy and culture. It’s also the only way a company can get currency to grow significantly by acquisition. And finally, it’s the only way to disrupt an industry, where you eventually become worth more than any of the companies that would have bought you. You’re right, these conditions probably occur in only 5% – 10% of any VC’s portfolio. I’d be interested to read what criteria would prompt you to consider an IPO?Separately, I think that among private investors and potential acquirers some companies actually trade at a discount to their public value if they do something profitable but operationally complex.

    1. fredwilson

      i don’t think that is true Glenni think a series of liquidity offerings will allow a company to stay private, direct its own growth, strategy, and culture, and also allow the early investors, founders, and mgmt to take some money off the table

  18. Matt A. Myers

    A side comment. I went to a local conference here a few months back. A representative from the Canadian National Stock Exchange was there on a speaker panel. He mentioned they were primarily interested in oil companies, natural resource related companies, etc. for IPO’ing. I asked him, what about internet? He started off with a laugh. I almost facepalmed myself. I felt like mentioning Google and a few other internet examples. I hope for Canada’s sake the TSX doesn’t have same attitude.I do see the potential of being gobbled up by a big company a way for a bigger exit though, especially if they don’t want you in the hands of another competitor.

    1. jchewitt

      The TSX used to have some internet companies…That’s just Canada’s focus at the moment. I mean… if there are no major web companies on the TSX, why not trail-blaze? Isn’t that a sign that there’s more opportunity than elsewhere?

  19. Dan Sweet

    Fred, is this the prelude to your promised “CFO vs. VP of Finance” post?

    1. fredwilson

      i didn’t think of it that way, but it is sure relevant

  20. jchewitt

    Thank you for this honest and transparent post on exits.If people want to create a sustainable entrepreneurial community, the IPO problem has to be licked.Many people are over-paying for legal services. I’m confident that costs can be slashed in that area with enough comparison shopping and intelligent outsourcing. The field of law in general is going through tremendous competitive pressures. Bid those prices down.People have brought up the AIM market. I’ve also asked a couple VCs (no financial relationship, not pitching them) about going public overseas. Their response was a “lack of liquidity,” with specific reference to the AIM.I’m also curious as to why you can’t just raise more money by going public overseas and issuing derivatives domestically. I may be totally off-base in that suggestion.If there’s a lack of liquidity overseas, why not create it? The only way to encourage major overhauls in the legal system is through using the threat of capital flight. And not just talking about it, but actually doing it. There’s no reason to kill a fund or let a company waste away due to fear and inaction.I’m confident that this problem can be solved without a doomed lobbying effort. Existing public companies with entrenched bases of influence in Washington LOVE the fact that it is so hard to create an effective IPO. It means that there’s more money going into their stocks than would be otherwise.In effect, the regulatory system is running a blockade on fresh companies. You don’t try to rush head-first into that blockade, or you’ll get mowed down. Figure out a method to make that blockade irrelevant, and the rewards will be tremendous.I’m trying to piece it out myself, but I’m really too out-of-the-loop, ignorant, and under-resourced to determine a solution.

    1. ShanaC

      Lawyers don’t need a bid down, they probably need a massive shift in how they practice. It’s partially happening. I’m still waiting on seeing what will come out in that space.

      1. jchewitt

        There’s a massive oversupply in lawyers. The law schools have been shooting out more graduates than can be absorbed either by large law firms or academia for years now.Since there’s an oversupply (and many jobs that used to go to associates are now being off-shored or automated), the price of legal services must drop.I also think that way more compliance stuff can be automated than already is. Law-hacker startup, anyone? 😛

        1. JLM

          No profession will ever self limit its membership if that profession can self regulate its own rates, regulation and licensing.What is needed is to limit the basic demand for services —Wellness v medicalArbitration v litigationMedical malpractice and tort reforms

        2. ShanaC

          I would love to do that. I did a chunk of the research- a lot of what we see is work is how lawyers interact with different documents and with each other.If you capture just 20% of the three largest markets and charge $100/month you’re going to make a huge chunk of change.

  21. Aviah Laor

    The idea of the IPO is to let non PE people invest BEFORE the hyper growth. But now IPO comes only after the full potential of the company is sucked, exploited and incurred in the stock price. So what’s the point?

  22. Costas

    Things like those happen in Europe for ages. You’ll just have to grow up and toughen up

  23. ShanaC

    Ok then- what should all this look like? What i see happening is as follows:1) Lots of seed funds/micro funds2) Lots of end stage funds that do the followinga) prep the few companies that can go to ipo for ipob) start doing the PE type thing where they have some leverage as the next stage of growth through the fund so that the company does have some access to the public market (no access is a little screwed up)c)start the other PE habit of trading companies so that you get portfolio exists. If not done well, this can cause bomb-out huts of companies.d)prepare another bunch for m/a. (although this could happen with type of portfolio a)C- now C is a problem. Eventually C needs to be solved because of the dangerous situation of bombout companies and board weirdness.1) the company could buy itself out over time2) dissolve3) find microcap stock offerings palatable- I don’t suggest sticking around jumping from portfolio to portfolio is healthy in any way either.

  24. ShanaC

    Also, last random though: I have no idea what the other guy is investing in, it seems to me that we might either be striking a pre-bubble in this period (because we’ve been in a dead economy for a while) and we probably aren’t lookign as closely as we should at say, non-consumer/enterprise/smb stuff which always seems to me still needs some massive shifts, however those are more time consumingIt’s like google with search. They were among the last in the game. Same with all of this stuff. The company to really make it will probably be some very odd suite of enterprise social networking tool. Not like a yammer, but something really focused on making work, workable.

    1. M. Edward (Ed) Borasky

      Like Jive Software?

      1. ShanaC

        Yes, except work with the federalized nature of certain industries, likelaw, medicine, bnking, where people are doing certain very similar things,but the things that are different are very different so knowledge that getsshared becomes valuable, even if it is shared acrosscompanies/fimrs/individuals. These sorts of industries have more logisticalhurdles to jump though (regulation)getting a bunch of law firms to all try out a concept piece of software is anightmare, even if you can get individual lawyers to recognize that theyneed to socialize their work practices. More interestingly, it would cutparts of their costs.

  25. paramendra

    The IPO is not the finish line, it is the gold medal. Most startups are not meant to see an IPO.

  26. Sfraise77

    The IPO is just so sexy though.

    1. Donna Brewington White

      The “IPO” has become something of a celebrity, hasn’t it?

  27. Sfraise77

    Fred..Please don’t hate me for getting off topic but I really hope to get your opinion on this.I’m a bit discouraged after reading an old blog post by another VC David Hornik.In the post he picks apart an old article in Wired on how to get venture capital.One of the things he is adamant about is a part where the article recommends going to the VC’s website and submitting a business plan via email as recommended by the websites.David strongly disagrees with this, claiming your business plan will most likely not get read by anyone that matters doing this, and the only real way to get a proposal in front of a VC is by referral. Now I understand that knowing someone that knows the VC is a major advantage, but personally feel it’s kind of arrogant to think that proposals submitted via email over the firm’s website are basically worthless, but if you happen to know someone that knows a VC then your plan is automatically better.For my situation, I’m situated in nowhere Iowa, a very long ways away from Menlo Park or New York. It’s not an easy thing making contacts in this venue when your closest neighbor is a good mile away and they don’t even know how to send an email let alone know a venture capitalist. That said, I’ve managed to spot a consumer internet market that was extremely soft but still has a high demand and high value. Then develop a site that takes advantage of that which has not only been profitable every single month for 2 years, but is now poised to quickly dominate the market. All of this was done by myself on a shoe string budget, the site is now growing by roughly 300 new members per day, revenue is about 500% compared to overhead, and traffic is estimated to grow by about 10 times by the end of the year without pumping additional capital into it. Of course I’m biased, but personally if I were an investor and looked at the business plan for this venture and saw not only the success it has now, but the incredible growth potential, I would think it was a no-brainer. But….I live in Iowa, strike 1.I have absolutely no contacts in the VC world, strike 2 and 3.Now I’ll be the first to admit that I don’t know a single thing about the VC world, I’m a developer not an investor. Before I decided to put all of my effort into this I owned an insurance agency, apples to oranges I know lol. All I know about VC is what I’ve learned through researching across the net on sites like yours and Davids. All I know is I have a business that could make some people a lot of money, but no idea how to get the funding I need to take advantage of the situation while the timing in the market is perfect. I don’t have to have funding to continue growing and making a profit so it’s not the end of the world if I don’t obviously, but I’m for sure afraid that I’ll miss a golden opportunity to corner the market if I don’t.Now that I’m done ranting completely off topic, what are your thoughts on cold submitting requests and business plans via email through the firm’s websites? How do you personally view these submissions, have you personally ever actually read a proposal submitted this way? If you were personally looking over a proposal from someone locationally challenged such as myself, would you consider that a major strike against funding the venture? Have you ever handed out a term sheet to someone that was not referred to you or the firm?Again, I’m sorry that I got off topic, but this whole process is such a mystery and frustrating to someone that has never actively sought out funding before, and the whole process seems stacked against you if you aren’t already a rock star like Bill Gates or Steve Jobs (or at least know them). The last thing I want to do is waste time on a wild goose chase so thought I would take a chance hoping you would demystify a bit of the process better.

    1. JLM

      The greatest challenge to raising money is to just ask for the money. And help.Call me @ 512-656-1383 on Monday and I will make arrangements to read your pitch. If it is any good, I will forward it to some VCs who are flush with cash — if it is in their space.No promises but it will get read.You are making this way too hard.

      1. Sfraise77

        JLM you rock!I would love your input and critique, if you think the whole thing is a waste of time by all means tell me it’s a waste of time. I’m a big boy and can take rejection, like I said it’s not an end to anything if I can’t get funding but I would like to at least like to get my proposal read by someone.

  28. Rahul Deodhar

    I think you hit a nail on the head and did not drive it in.If returns from late stage private finance are higher why do entrepreneurs not go for this option? Are they bad investors? (going for lower return in public markets vs. higher returns in private ones) I don’t think so.I believe, entrepreneurs want to reduce the bargaining power of investors. A private investor for a 10-25% stake is way more intrusive than a public shareholding of similar amount. Knowingly or otherwise, this aspect plays a very crucial role in deciding the source of funding. This is an open “dont-ask don’t tell” reality in IPO segment.Second is the use of proceeds. Not many people (public investors) concentrate on intended and actual use of proceeds. Private investors have a hawk-eye on where the money is going. Some entrepreneurs are like authors. They want their first success to finance other venture of varying, or even altogether different risks. They get to play this game with public investors.

  29. Venkat

    This would make a good MBA Mondays topic: exit strategies, and what they cost, and when they are a good idea. What makes an IPO so expensive in fees alone? Is the regulatory compliance burden that much higher for publicly held vs. privately held corps? Is there a minimum revenue/margin threshold at which it makes sense to take on the burden?

  30. reece

    On a recent call with a VC, we discussed potential exits and his general advice was ‘plan to build a business that lasts and that you’ll be running forever.’It wasn’t negative in tone at all. He was just saying you can’t perfectly plan your future exit and your best option is to create long term value.Ultimately though, when you do that, you’re more likely to be attractive to others.[I’m late to the comment thread, so pardon me if this has been said in one way or another].

  31. ceonyc

    While the outcome for an M&A event may be better for the investors, look at the outcomes of the companies and the ideas themselves… I don’t think they’re faring much better. Tacoda, del.icio.us, Feedburner…Seems like any way you slice it, the long term prospects for the perpetuation of new ideas as good streams of cashflow generation/continuous innovation aren’t that good.

  32. World Cup

    “Since that experience, I’ve become very wary of the IPO exit.” The exit strategy is always highly important

  33. Geoff

    Although I haven’t read everyone’s comments, I have a few simple take-aways from your post. First, at a high level, there appears to be a genuine business opportunity for boutique law firms, accounting firms, and investment banks to offer more competitive pricing to VCs and entrepreneurs for IPO exits in any economic climate. A lot of things have to come together for this to happen, but it appears to be a “back to the future” scenario. Second, for your second more recent IPO story, is the lower valuation more a reflection of the current market conditions, which at some point in the future will increase as part of some business cycle? Does it mean the late stage financing valuations are independent of market conditions or simply optimistic? In comparing my valuation model to your predictions, it does look like there is no more than a 11% chance to have a successful exit (assumed to be either IPO or acquisition) in the current market and no more than a 22% chance to have a successful exit in a “normal” market. Assuming an IPO market exists, it makes sense to assume the probabiliy of an IPO exit (I didn’t calculate it) is even less…and should be reserved for only the very best portfolio companies.

  34. Nawaooo.com

    I recommend the book ‘The Second Bounce of the Ball’ by Cohen. It talks a bit about the difficulty they went through to create an early stage stock exchange. Its difficult. I wonder what all these means for those of us who really believe that one day Tech companies will be huge in the frontier market called Africa and hence are creating companies like http://www.nawaooo.com — Nigeria’s number 1 business directory and http://www.afrongroup.com — an African startup incubator. The work needs to be done, the opportunity is significantly large, but can we exit one day?

  35. Rosswhiting

    Buyouts are the new IPO.

  36. everploeg

    I don’t think there is any way to argue with the logic of this post. IPO values do indeed seem to be at/below late stage private company financings. But, there seems to be an obvious and important question that I didn’t see addressed in any of comments: where is the arbitrage opportunity? If the IPO valuations are “too low” and the late stage private valuations are “too high”, on a risk & liquidity adjusted relative basis, it should be possible to extract value from the systemic mis-pricing.

    1. M. Edward (Ed) Borasky

      Exactly! Without a *regulated* *public* market for the debt and equities of “startups”, it’s *not* possible for these “securities” to be priced, hedged, etc. To quote John Wayne, “Life is tough, but it’s tougher if you’re stupid.”

  37. George A.

    Is that the real Henry Blodget? … Will the real Henry Blodget please stand up, please stand up… coolI assume by liquidity offering you mean a vc round which partially cashes out prior investors?The growing disparity in valuations between public and private markets is pretty astounding and by definition unsustainable. If VC is confined to exiting to other VC’s or a small handful of strategic acquirers (GOOG, AAPL, MSFT, YHOO, all public but ultimately are large enough and have enough temporary street credit to overpay for “strategic” assets) then you effectively have the makings of a ponzi scheme.From my experience, only the least self aware VCs are not fully cognizant of this risk. They all know that when they invest into a C round at a multiple of where the public markets would likely value the business in question, they are taking enormous risk on behalf of their LP’s.The counter argument (the one you hear in candid conversations) is that if you are a VC and you attempt to value private assets in a comparable fashion to public markets, you get laughed out of the room. Angel’s stop showing you deals, you no longer get invites to heady conferences and you are effectively out of business. You raised capital to invest, your lp’s expect you to invest. So you invest… at market clearing prices. Demand exceeds supply, so a bubble is born.Just like other bubbles, a separate market will exist right up to the moment where it doesn’t. Then… “gulp… how much free cash flow do we have?”

  38. Pat

    How about just building businesses that provide a nice steadily increasing dividend stream with Y/Y growth in the 20% range?In other words, instead of looking for that definitive exit – do the old fashion thing of building long-term businesses?Sigh- I know “old-school”….

  39. Len.Williams

    The IPO used to be the ultimate exit for a venture backed company. Have things really changed now? The liquidity options for emerging or struggling companies aren’t very encouraging these days. Although private equity firms are choosing to bring more mature companies to market these days, the quality filter of investors, although prepared to consider new issues seems to be higher and higher.Well, now it’s like a macro versus micro debate. While the market is focusing on macroeconomic stability, the IPO markets might struggle… The decline in equity markets is putting a heavy chill on IPO market. It’s a global phenomenon. Maybe things will start to change in the second half of the year…A presentation about how to (still) raise capital that may be encouraging for entrepreneurs:vcgate – How To Raise Capital

  40. Fred T

    You have a point there, and if you are talking about different “invisible hands” of economic, political, and social rule, then that is correct. Although this paradigm does encompass the current system of our nation, I wish this was ultimately true on the department level.It is sad to say that most of the institutions that allegedly co-exist or are interdependent with each other apparently do not work together like we ideally thought they would. CIA and FBI, Homeland Security and NSA, Wall Street and Federal Reserve, jurisdictions in different areas, the lists are endless. They may work on a top-level ideal when PR is involved, but that is only as far they go. Correct me if I’m wrong on this, but you will be surprised on how much autonomy these individual departments impose on themselves while treating the other institution as a foreign body when it does not involve a national crisis.That said, subtle imposed autonomy by different governing entities may be one of many cases why there are “opposing” factors contributing to a successful IPO. Instead of imposing fees, why not implement programs that would cut these costs and have involved institutions work better with each other so companies are given more incentives to push these offerings?

  41. Mark Essel

    Spot on analogy FJ. We have to work to build smaller/simpler social exchange structures. Wall Street isn’t scaling well for Earth.

  42. William Pietri

    You’re unlikely to get both free and decentralized markets at the same time. Monopoly and oligopoly powers are too great, so companies grow very large, becoming too big to fail. Allowing national banks and mixing commercial and investment banking in the same entities made things freer, but more centralized, and more entangled.Better to pursue vibrant, decentralized markets. For example, here in San Francisco, we limit chain stores. There are a few Starbucks, but they don’t dominate the market. As a consequence, we have a number of excellent, world-class coffee shops, all independently owned and competing vigorously for coffee-drinker dollars.

  43. JLM

    I get your example and it supports your point completely.Picky little detail — only one climber should be moving at a time and the balance should be “on belay” anticipating that the climber may fall and the entire team is otherwise braced for that eventuality.The climber is tapping in pitons as he goes so that the first line of defense is simply the fall from a single piton length.That way the risk is not only mitigated but the countervailing force is multiplied by the number of other climbers.Kind of like the FDIC used to be once upon a time.

  44. Harry DeMott

    I’m not so sure that leverage is healthy. For an investor it magnifies returns but diminishes your margin of safety. Almost all great financial collapses happened due to too much leverage in the system – and the delvereaging just killed people left and right. Good business or bad – too much leverage kills. Are they’re times for leverage – absolutely – like when you have the opportunity to expand your business and the returns on the projects you want to pursue are far in excess of your cost of debt – and you can afford the debt without the expansionary plans – but as used by PE firms – forget it – they’re just buying ordinary businesses and magnifying the bet. Give me 8/1 leverage and let me pick the time I will sell the company in the net 7-10 years and complete control of management and the balance sheet in the meantime – and I’m guessing I could show you decent returns. The actual unlevered returns are not all that great – these are not investment geniuses – they are marketing geniuses, for getting people to give them capital and leverage on these terms. More power to em!

  45. Mark Essel

    The trick is to strategically cut programs to get the outcome we’re looking for not necessarily create more programs. Very natural and real forces will help us make our system more efficient and equitable (personal greed balancing against social care).Here we project off the cuff ideas and let a pool of sharp simulations feel out changes (other readers). Taking initiative on a sound path is the next rational step.

  46. JLM

    Is the example you present an economic issue or a “local” issue or a lifestyle issue?At the end of the day, your example suggests that the basic property rights of a business should be trumped by local governing philosophy?That competition in the marketplace should be manipulated by a heavy thumb on the scale administered by folks who are not business people?I love San Francisco but is it really part of the real world?

  47. JLM

    Leverage in the context of buying companies is entirely different than leverage used in the ordinary course of running businesses. A keen observer notes the differences and uses them both wisely.With the almost unprecedented low interest rates available today — element of art being whether you can get the damn loan or debt instrument to start with — businesses should be stocking up on as much debt as you can get your hands on. Particularly on the buy side.If you can’t chin up 30 day LIBOR + 0.3% get out of town!Once you own the little beastie and are looking at leverage as only an operating characteristic, you must burn off the debt as quickly as possible. And why not? What else can you really do w/ the money?Money has a Janus type split personality and is either debt or equity and is priced differently. Right now debt is very, very, very attractively priced. The bitch about being a contrarian is actually being one.

  48. kidmercury

    local currency for sure. it’s how we build the new world order.

  49. Dan Sweet

    ok, I’ll nitpick your climbing nitpick. roped up team members often move at the same time without anchors in general mountaineering/glacier travel. the “anchor” is a climber’s ice axe and self arrest technique if they see something going down and have time to react. your piton/anchor/belay scenario is true for more technical rock/ice sections of a mountain climb as well as almost all rock climbing.the unroped mountaineers are the “we can regulate ourselves crowd” and the systemic risk that wipes the whole line of them out is an avalanche. the anchor/belay/one moving at a time thing thing is the basics like capital requirements, FASB standards, etc.

  50. JLM

    “roped up team members often move at the same time without anchors in general mountaineering/glacier travel”Uhh, we used to call that “hiking”! LOLThe second a chance of sliding to one’s death appears, it is fundamental and basic safety to be roped, anchored and have a single moving climber at a time. Sticking one’s ice ax into the snow a time or two and attempting to arrest one’s rendezvous with destiny makes one fond of basic safety.Having joshed you just a bit, your analogy is perfect and well founded. Well made!It has been some considerable time since I have done violence to a defenseless piton but there was a time…back in my prime…