Bashing The Collective Wisdom On IPOs

Bill Gurley penned a fantastic post about IPOs yesterday. Go read it.

Bill presents a very compelling case that IPOs still have a role to play in the startup ecosystem and he also puts forth some strong data suggesting that the IPO market is coming back and good companies are taking advantage of it.

But my favorite part is his counterargument to the point that Wall Street forces entrepreneurs and managers to run their companies with a short term focus (an issue I've long been concerned about). Bill writes:

One recent argument knocking the IPO is as follows: Wall Street is too short-term focused, and that if you want to run your company for the long-term you should remain private. There are three great reasons that this “can’t focus on the long term” argument falls short — Jeff Bezos, Marc Benioff, and Reed Hastings. All three of these amazing entrepreneurs turned CEOs took their company public on a standard IPO time frame. They also all three conveyed to Wall Street that they would postpone short-term earnings results in order to chase a greater long-term objectives and ambitions. The intelligent mutual fund investors that were swayed by their convincing arguments (there were many) were handsomely rewarded. Furthermore, Bezos, Benioff, and Hastings all three used “being public” as a bully-pulpit to tell their version of their industry’s story, thereby aiding their advantage. If you are unconvinced go ask Steve RiggioTom Siebel, or Blockbuter CEO Jim Keyes.

Back in the late 90s, my prior firm had somewhere between a dozen and two dozen IPOs out of a portfolio of 50 some names. Many of those IPOs ended badly as the companies failed and were sold for way less than the offering price. That experience taught me a great deal and as Bill notes in his post, I've been bearish on IPOs since then.

However, even in my most bearish posts on the topic, I've always said that the best 10% of venture backed companies ought to at least consider an IPO. If you are operating a business with the potential of a Netflix, an Amazon, or a Salesforce, then you are in a different league and the IPO should be in your playbook. Whether you actually call that play is another story, but it needs to be there.

We have close to forty portfolio companies now and I can easily count four of them that someday will make great public companies. In my view, you need to be able to say yes to all of the following questions to have a great public company:

1) Market Leader

2) Sustainably Profitable

3) Strong Top Line Growth For As Far As You Can See

4) Strong Management Team With Public Company Experience In The Key Places

5) A Willingness To Build The Company Without Regard To Short Term Stock Price Movements

6) The Ability To Credibly Trade At A Billion Dollars of Market Cap Or More

If you have a company that fits that bill, then you should absolutely be thinking about an IPO. But if you don't, then you should think about some other approaches to exit, most likely M&A to a strategic or financial buyer. You may also want to consider secondary sales to provide liquidity while the company continues to build toward an IPO or a sale.

Bill's post is well timed. The startup sector is on an upswing and there are quite a few really strong businesses out there sitting in venture capital portfolios. If those companies and the VCs behind them are careful and thoughtful about going public, and if only the best companies choose that route, we could see a healthy and vibrant IPO market for startups reappear in the coming years.

#VC & Technology

Comments (Archived):

  1. Matt A. Myers

    I’m at pretty early stages of my startup but I’ve been thinking through IPO.I think you’re right, and that at a certain market cap it just makes sense to tap into the public markets.The cash that will come in would be able to allow magnificent things to happen in any company with longer-term vision.

    1. InTheBox

      if you need the cash, you’re not a candidate for an from the ipo will go to paydown the convertible notes that your series L investors saddled you with.Don’t worry, they got warrants too so they will be standing right next to you while you clap in front of that blue screen…

  2. David Pakman

    Fred, good list of IPO criteria. However, if you’ve got to expect to trade at $1B+ to be public, doesn’t that allow M&A valuations in the sub-$1B range to be depressed (given the companies have no public route as an alternative valuation), and doesn’t that negatively impact those of us investing in companies that expect to M&A at less than $1B?

    1. Jack Sinclair

      I don’t think you need to be $1B on day one to go public, just be able to show the path to $1B. The sweet spot right now for IPOs is probably in the $400MM valuation range.

      1. fredwilson

        the problem with $400mm Jack is the stock will be too illiquid for many of the larger funds$1bn is a safer place to be

        1. PhilipSugar

          I agree with your assessment, but I think that is a large part of what is wrong with Wall Street. There is no reason with today’s technology this should be. It should be going the other way (towards smaller cap) but instead because everybody wants to use the technology to trade instead of serve the original purpose (raise growth capital) its gone to where you need to have a market cap greater than $1B

          1. ShanaC

            what is causing that

          2. PhilipSugar

            Money.Go to a Sunguard Datacenter and see how everybody wants to be clustered on the same switch as the exchange computers.It used to cost real money to trade. Now you can throw in a huge order and then cancel if there is nobody to get in front of. You basically steal nickels all day long.It used to be Wall Street firms were partnerships where your wealth could be wiped out if you had some group taking high risk strategies, and you really didn’t have anyplace to go….partners move to other firms very infrequently because of the nature of the structure. Now as an employee you watch the stock blow up and merrily move to another firm.

    2. fredwilson

      yes, but the secondary market is providing some good alternativesthere. i think Yelp’s deal with Elevation as they walked from Googleis a good example of that

      1. ShanaC

        how liquid is that ever going to become….

    3. Philip J. Cortes

      Great question David.One advantage the M&A markets have over IPO’s is that there can be competing acquirers. This may be the way the M&A valuation depression you identified is naturally combated for companies in the sub-$1B range.

      1. Healy Jones

        While I no longer know if this is still a viable strategy, in the middle of the 2000’s I saw several venture backed companies enter the IPO reg process while they were being courted by acquiring companies. The IPO represented a strong alternative to the M&A exit and was used as leverage to get a fast(ish) M&A exit at a good value.

        1. mike gilfillan

          Personally I agree with everything Fred stated, which is why I was not a proponent of taking my $10m IT job site public back in 1999. But I saw my competitors who did IPO using 3rd tier firms gain the lion’s share of attention on the M&A front (ie: Headhunter selling to CareerBuilder and HotJobs selling to Yahoo!)I imagine that in a frothy IPO market, the same thing will happen again and those that file their S-1 even with a bucket shop can gain a leg up on the competition (but it’s a risky move if you aren’t in it for the long haul).We decided to retrench and focus on a 2nd revenue model that could justify $1B (or is it $1bb 🙂 We were proving the new model when we ran out of runway in 2000 because of the crash, but that’s another story.

  3. David Semeria

    So, the glass is actually half-full 10% of the time 🙂

    1. fredwilson

      it was your tweet that tipped me off to bill’s posti think we need more blogging back and forth, riffing on other’sposts, i like doing thatso thanks

      1. David Semeria

        As Tim O’Reilly would say, your blog creates a lot more value than it captures…So it’s us who should say thanks.Thanks!

  4. Christian Brucculeri

    Which 4 companies? I don’t expect an answer, but would love to get an idea of which market sectors you believe will breed companies with top line growth for as far as you can see.

    1. fredwilson

      business insider took a guess at that questionhttp://www.businessinsider….

  5. andyswan

    It takes two to tango. “Wall Street” (investors) is often concerned with short-term results because that is the story and results that the company itself is perceived to be focused on.With ANY investor, private or public, it is paramount that you clearly define your company’s objectives and timelines. Don’t toot your horn on this quarter’s QoverQ traffic growth to distract from your sales flatlining….unless you want to be measured on QoQ traffic again 5 quarters from now.That said, it is extremely important to break your long term vision into short-term bites, WITH objective measurements of success/failure that occur at regular, short-term intervals. But it’s up to YOU to set what those are and shape the message….and it’s even more important that you remain consistent with those even during the tough times.If you are honest with yourself and your potential investors, you will attract the kind of investor that you want to have. Interests will be aligned, and initiatives that align with the clear mission will be supported.

    1. fredwilson

      great advice andy

  6. RichardF

    Let’s hope we see a healthy IPO market reappear. It’s great PR for the start up community. Betfair had a successful IPO here on the LSE last month, 5 years after a planned IPO was pulled in 2005. A ten year overnight success story.

    1. Dave Pinsen

      There’s already a healthy market growing for Mongolian IPOs (some on London’s AIM). A fellow on Bloomberg TV earlier this weak said Mongolia’s economy is expected to grow at ~15% per year for the next several years. Enormous mineral wealth there, most of it untapped.

    2. Fernando Gutierrez

      Yes, PR is very important. It may sound vain, but if you want more people trying to start companies instead of trying the next trick in Wall Street you need the covers and Forbes’s lists that come with IPOs. Entrepreneurship in much more than that, but most people won’t ever think on it, so some flashing lights can’t harm if taken with some modesty.

    3. ErikSchwartz

      The last thing the start up world needs right now is more PR.The start up world needs more companies that generate demonstrable revenue for themselves and (if applicable) for their customers.

      1. RichardF

        Depends where you live Erik and I can tell you in the UK it is much needed

        1. Fernando Gutierrez

          I think it’s really needed in Europe in general… not a coincidence that you make the comment and David Semeria and I are the ones who like it! However, I can agree with Erik that a PR excess can be bad, but even in the US I don’t think that everywhere is the same. I travel to Cambridge every few weeks and entrepreneurship doesn’t have a PR problem there. And if there is a problem it’s too much PR. And I guess that in the Bay Area and other hubs it’s the same. But when I go out to other regions I don’t feel that’s the case. Obviously, I can’t talk about everywhere and everybody because my knowledge is very limited, but my friends in NYC or Miami think very different about entrepreneurship to the ones in Cambridge.

          1. RichardF

            If I think about it I disagree with Erik even in the US. Better to be in the situation where entrepreneurs are out there creating stuff (even if some of it is fluff) and getting funded than not given the dire global economy in my opinion.

    4. awaldstein

      5 year overnight success story…I like that.Friends of mine at RealD, a company I was involved in years ago, just did the same. Almost 10 years changing the world for 3D cinema then an overnight IPO success. Good for them and great for anyone who just won’t quit and makes it work.

    5. ShanaC

      I’ve been hearing yes to that, via the WSJ…no web software though…that would be good news

  7. LECHSAM group

    @lechsamgroup: Timing still a challenge; but US IPO market is regaining its strength

  8. Druce

    If there’s a big new computing paradigm like social/cloud that does come along with a big bull surge of IPOs (ahem cough, @#$ubble, I didn’t say that!), it will be the first time.Interesting why it hasn’t happened already… Sarbox, forbearance of SEC allowing companies like Facebook with lots of shareholders and a trading market to remain private, availability of big private money, fallout from the dot-com collapse?

    1. fredwilson

      all of the above and more

  9. SEO

    Nice post – have had concerns about this myself – not just about the short-term focus but also about the plundering that is going on in public companies. Now, you mention good companies using the IPO process to grow their operations. But, what about this GM thing (guess we really do not learn from the past)!

  10. RacerRick

    Can we please get Twitter on the IPO train?

    1. fredwilson

      it doesn’t check the box on all six yet

      1. Kenyan

        This blog is fascinating to me.Where does Twitter fall short in your eyes, Fred?

        1. fredwilson

          i am not going to say morei’m on the twitter board and i should be careful

      2. baba12

        would Greed be the seventh on the list to check off.I ask this because if a company is sustainable and delivering the results that it is based on the six point check list, why relinquish control to Wall street which is only greedy.I don’t believe Wall street has any intentions to nurture and build a company to deliver products and services, they just want to make sure they buy low and sell high.

  11. Harry DeMott

    I’m not sure I agree with #6 on your list.The real question is the value of the company coming out of the IPO and how much float you are going to have in the market at any given time – not only from primary shares – but from selling shareholders (i.e. the VC’s and other investors that got the company there to begin with).If you can get $200M or more of float in a name – you can certainly get a reasonably trading stock – especially if you plan on growing.Remember, IPO’s are growth capital. Yes, they are a liquidity event for everyone involved – but they should be seen as just another round of financing aimed at accelerating the rate of growth for the company.Until recently, when bond yields collapsed and QE2 continued to pump more and more $ into the system – forcing people to seek more equity like returns, the IPO market may not have been the best for of funding for a fast growing late stage round. Add in the extra costs of running a public company, the scrutiny, the demand for quarterly performance, etc… and you really needed a premium in the public market to head there.Now look at Open Table – and the valuation they are getting – look at Netflix, or any of the other companies mentioned in your post and Bill’s post – and it is clear that some of the winners in spaces will get that sort of valuation from the public markets – making them the best source of growth capital again.So to come full circle – I don’t think you need #6 right off the bat. What you need is #1 – #5 in spades – and if you execute – #6 will follow. Particularly #5.Public market investors are like dogs. They beg and they whine and they play games – but ultimately they get used to what you give them and how you treat them.NFLX is a great example of this. They have always been long term focused, very transparent, and they made the very smart move of taking all of their conference call questions ahead of time via e-mail – so they could get through more stuff – rather than read the press release for 30 minutes of an hour. As a result, those that bought in have been well rewarded – and those who couldn’t handle it – well they missed the ride.

    1. David Semeria

      “Public market investors are like dogs. They beg and they whine and they play games – but ultimately they get used to what you give them and how you treat them.”As someone who brokered to such people for 10 years, I can’t think of anyone who matches that description.

      1. Harry DeMott

        I don’t know if you are being facetious or not.I guess what I am trying to say is that if you set the boundaries as acompany – then the markets will always ask for more – but in the end as longas you hold firm and don’t bend on what you are going to give them – theybehave very well toward you and take what you give them. As soon as youstart catering to the street – they will take everything you give them andthen ask for more.

        1. David Semeria

          I wasn’t being facetious – but, given the context, I can see how my comment could have come off as sarcastic.I don’t think all the blame should go to investors. I’ve seen top management focus on the short-term many times – simply because that’s how their compensation packages were structured.It never ceases to amaze me how markets made up of some very smart and rational people (on both sides of the fence) collectively can’t see beyond their own nose.

          1. Harry DeMott

            Absolutely. Short term incentives are certainly the bane of public marketcapitalism. It’s why I always hate those compensation lists – where theyshow some CEO got paid $50M this year – and when you look at it – it is fromthe exercise of 8 years worth of options. People focus on what is measured -so measure long term results.

  12. JLM

    Running a small public company and having run some fairly large private companies, I am often amazed at the level of misinformation folks embrace in regard to the differences.The liquidity offered by the public aspect of public companies is both a blessing and a curse — a blessing when you are in a position to liquidate a bit but a curse when you are an SEC reporting entity by virtue of your position or gross stock holding level.It is not so easy to sell 400K shares if you are the CEO and a Director. And, if you do, you have to file a Form 4 within 2 days, so the negative implications are quickly aired.I do not agree with the proposition that there is a level of market cap which is essential to the full valuation of a business though I do agree that it is a bit easier to be GE than Wee G when it comes to wowing the analysts.The arbitrage of a 14 P/E of a public company in its acquisition of private companies was, is a bit and will be again a real arithmetic multiplier. There is a huge value placed upon being able to put in a 10% stop loss order and somebody has to pay for the privilege.However, there is a very, very, very well developed Investor Relations community out there which provides a platform for any company to tell their story. There are a few minefields but the world is replete with garden variety IR firms who are specific to size and industry as well as tons of conferences which highlight the merits of presenting firms and the proliferation of newsletters and websites is quite remarkable.The story is a bit different story as it is not about raising money FOR the company but about getting a fair value for shareholders who already own the stock.A good company can create its own IR program with an “opt in” strategy which provides the opportunity to disseminate the requisite Reg FD information and SEC filings in a manner that they take on a bit of attraction to investors of all stripes.Since we are likely talking about nano-cap, micro-cap and small cap stocks here, it is particularly gratifying to see that there is a new democratic lens placed over these “little people” by the over arching view of the Internet. It is pretty damn hard to keep a secret these days.If you want an insight into how powerful this can be, take a look at the stock holders (SEC Form 13F filers who manage $100MM of more) of companies in a particular industry or of a particular size. You will be surprised at how many there truly are.

  13. lushfun

    I actually look to DDH and think if you build something good no point going public of getting funded just enjoy your lifestyle and work with it. If the business is sustainable, not necessarily a market leader you can have a niche and work well without straining into the ipo / funded sphere.If your building something mind as well build it well enough to keep… and if your selling it then that might have been the goal all along.

  14. Kyle Pearson

    Fred, for those of us that have limited knowledge, have you ever made a post detailing the most common types of liquidation events that VCs participate in to get their investment back? Obviously IPOs get the most attention, but clearly they are smaller in number. Acquisitions, later funding rounds etc? The question’s open to anybody who has an answer.

    1. fredwilson

      i think i’ve written about this in the past but i can’t find itin any case, about 75-80% of all exits are M&A

  15. James Siminoff

    loved this post Fred. I think it is more the CEO’s then the markets that push for this short term thinking.

  16. paramendra

    The IPO is not for every startup. It is not for most startups. There are many other respectable exits, like you point out. And, yes, the recession is over. 2011 will see some great tech IPOs, I believe. We will have a good few years.

  17. William Mougayar

    I don’t doubt that there are “quite a few really strong businesses out there sitting in venture capital portfolios” that could lead the way. But what we need to watch for is that this first initial list doesn’t get followed by a less careful and less thoughtful batch that could spoil the party.A healthy IPO market is a great motivational factor for building great companies.

  18. Michael B. Aronson

    Last week Amazon purchased our portfolio company Quidsi, the operator of Diapers and has been our plan that this would be the one IPO in our portfolio of 25 companies and we were working with a leading investment bank towards that end. We had almost all of the criteria and road map to get the other ones (CFO with public experience , new board members to replace vcs, and yes profitability) and a brand that would benefit from the additional visability. The biggest reason to do an IPO would have been the substantial capital required for them to build out their success in the Baby vertical in 10 to 15 other killer categories. Its hard to turn down $500m and immediate liquidity for everyone involved but it stings a bit not to have a shot at multi billion market cap. As a small VC, it sort of like being a race horse breeder who needs to sell the best ones to feed all the others back in the stable and keep the investors happy.

    1. fredwilson

      tough call Michaeli’ve made the “sell the company” call so many times in that situationbut after 25 years in the business, i am starting to think its thewrong call if you can build something hugei am not being critical at all since i’ve done the same thing so many timesbut how many “shots on goal” do you really get?

      1. Michael B. Aronson

        As the A round investors, it wasn’t just our “call” and each of the B, C, and E investors and founders had different risk/return profiles and throw in higher tax rates in the future for good measure. At 53 and on my third career, I don’t know if I will have any more “horses” this good, although I certainly hope so and the deal flow has certainly increased since the announcement.

        1. Thanks

          Michael, thank you for sharing this personal story. It took courage to be so open and I found it illuminating.A finance guru once told me that financing should be about raising money, not making money. In other words, raise capital to grow the business not to cash out. Unfortunately, as your story demonstrates, few situations are as simple as that, with the incentives between executives and investors in different tranches can vary significantly.

  19. Senith @ MBA tutor

    Youve got to be honest on handling the pressure from the street and if you can manage it. Jeff Bezos shares his learnings in the youtube video. Great stuff

  20. Vcinvestor

    I have had limited experience with ipo’s but my feeling was that the nature of the board meetings changed after the ipo. Far more attention needed to be devoted to issues concerned with the new constituencies (institutional shareholders, regulatory authorities, etc) and away from the business itself. And, on top of the point made by Fred about needing to see a one billion market cap in the future, I believe there is a good chance the owners will enjoy the business far more as a private concern than being public. Another entrepreneurial concern should be family financial planning. An ipo may not resolve long term family financial planning issues for the entrepreneurs (lockups, etc). An up front cash offer from a trade buyer can solve that problem. Then either the entrepreneurs really enjoy working with the buyer (probably not very often) or they have the cash and contacts to go out and do it again. The same applies to a financial buyer but with the likelihood of a more pressured environment as the new owners search for more rapid financial progress than the entrepreneurs feel is appropriate.I believe that whichever way entrepreneurs chose to go it is important to analyze carefully what they are losing in exchange for the first check. The ipo is ego satisfying, it creates lots of cocktail chat, creates cash in hand and there certainly is a real measure of achievement. Just be sure to assess the downsides since the decision is rarely reversible.

  21. Brent Harrison

    Let’s hope your premise is right Fred. And this time let’s hope investors and the markets are a little more conservative with their outlook.Cheers,Brent (@SmokeJumper)

  22. gart davis

    Really sad to read this post.I guess I was imprinted with the notion that access to public markets is a fundamental of capitalism and a foundation of our entrepreneurial success as a nation. Its heartbreaking to read such a clear and simple statement of its immensely diminished importance in the current world. Like someone explaining how in the 21st century we’ll only hold elections for about 10% of our presidents or something.I was employee #11 at cambridge technology partners, a firm that IPOd in 1991 as CATP with about $20m revenue run rate. Later, a company I founded was acquired by ProsoftTraining, trading as POSO, also around $20m. Those companies used their access to public finance as a relatively early step in fueling their growth. I feel lucky to have been alive and in the workforce when things like this were not only possible, but common.I know that your rules are a response to the way the world is structured now. We had the great bubble, the great corruption, and the great legislative over-reaction. I can’t help hoping that all this wisdom is for navigating a temporary aberration, and we’ll be moving on to a new and improved capitalism soon.