Despite the fact that the number of IPOs (Initial Public Offerings) for startups have continued to stay low, I still hear it touted often as the preferred exit strategy. I suspect the exuberance for an IPO is still being driven by the highly visible successes of a few companies several years ago, including Facebook, Yelp, and Twitter. Everyone dreams of becoming a billionaire overnight.
According to Investor’s Business Daily, even though IPOs in 2018 through July were up nearly 39 percent from last year, the total of 115 companies so far is still nowhere near the rate required to match the yearly total of 486 hit way back in 1999. The market for recent IPOs also remains extremely volatile, and as a result many of them are currently trading below their opening price.
Concerns over valuations being reset to a new normal, and a soft exit market, are seen as key drivers. Yet I believe the trend will continue flat as entrepreneurs become more aware of other considerations that make the IPO route less and less attractive. These include the following:
- Taking a company public is an expensive process. It will take many months and require endless amounts of time, money, and energy. According to a dated but still relevant study by PricewaterhouseCoopers, companies average $3.7 million spent directly on their IPO, in addition to underwriter fees of 5 to 7 percent of proceeds. It takes real money to find money.
- Make sure you can effectively use a big cash infusion. There is a big difference between needing a million dollars versus $100 million, or even a billion. New stockholders will expect to see rapid growth. You better have lined up a major international expansion, some major acquisition candidates, or a wealth of unfilled orders.
- There are real ongoing costs of maintaining a public company. You will need an experienced CFO, and the best legal and accounting help to comply with the audit requirements of the Sarbanes-Oxley Act. PwC estimates that public companies incur an average of $1.5 million in annual recurring costs as a result of being public.
- Exposure to increased liability risk. Public company executives are at civil and even criminal risk for false or misleading statements in the registration statement. In addition, officers may face liability for misrepresentations or speaking out in public and SEC reports. Executives shoulder new risks for insider trading and employment practices.
- The public company corporate culture may not fit you and your startup. Public ownership usually lends prestige and credibility to your sales, marketing, and acquisition efforts, but it may work counter to your vision of saving the world. Most startup founders voluntarily exit or are pushed out, and the fun is gone. Analysts want escalating profits.
- Public companies bring new expectations of benefits. If you want to give stock options, or have already been giving them, the employees will love the liquidity of their options, and the thought of selling shares for a profit. On the other hand, “competitive” salaries will likely go up, and health and retirement benefits will jump to a new level.
- Market volatility usually hits public companies first. Private companies can often fly under the radar in turbulent times like the recent recession. Public stockholders are more easily swayed by emotion and the activities of the crowd, rather than real market conditions, and all performance numbers are public. Shareholders can jump ship quickly.
Before you forge ahead to an IPO, I recommend a thorough readiness assessment, to quantify the need, as well as to identify potential gaps within processes, areas needing internal controls, and positions requiring enhanced technical accounting skills to operate as a publicly-traded company.
The costs of an aborted IPO are sizable, and may not be deferred to a later period or offering. Along with the time and effort required, this can severely cripple your company for an extended period, not to mention your entrepreneur lifestyle.
While the wins can be big, I still see the IPO option as one to be considered only under exceptional circumstances, rather than as the default exit option. Your odds of hitting the lottery may be better.