The Shape of Bubbles – Ripples Beneath the Surface

I have become fixated, if not quite obsessed, with thinking about what will happen when the venture spigot gets shut off. I having been writing a lot about this (and here). There is a lot of uncertainty out there on this subject, but I have boiled it down to three things about which I am fairly certain:

  1. At some point, it will become much harder to raise a venture fund and thus much harder to get funded by a venture investor.
  2. This is normal. The rest of Capitalism calls it a business cycle, and it does not have to end with a “Bursting Bubble”, or a post-cataclysmic landscape.
  3. It is very hard to predict who will suffer most in the downturn. There are lots of interdependencies which means that problems in one area can cause much bigger problems in another.

Beyond these, it is all open to debate.

I have been going back and forth on this subject with a few people lately. And there has been a growing chatter in the venture community on this subject, largely spurred by Benedict Evans’ piece (my response here). Fred Wilson at Union Square Ventures had an interesting post on the subject as well. His views are very similar to mine – capital flows matter. In fact that was one of the first posts on this site.

Of course, the fact that post is over three years old should make it clear that predicting the timing of downturns is impossible.

Nonetheless, I think it is worth exploring more, to prepare for that inevitable downturn. The world of finance has been grappling with this subject for a long time. (Some would say the whole basis for finance is the preparation for downturns.) And a key concept in managing for risk is the idea of diversification aka not putting all eggs in one basket. For instance, do not put all retirement assets in one stock, because any number of random events could wipe out that company. Better to buy multiple stocks (or a mutual fund), and better still to buy stocks and bonds and real estate etc.

At its heart, this is the idea behind a venture capital fund – lots of companies in the fund may go bust, but no single disaster can wipe out the fund, giving time for the other companies to find their inner unicorn.

For companies, however, diversification is much harder. We do not like to invest in companies that do too many things – they lose focus.

So it seems to me that understanding the risk landscape for the Someday Downturn is to understand where companies are exposed to risk. I tend to think of this as being ‘levered’ to something. Start-ups are levered bets on some form of technology. They are betting big on a particular outcome.

Of course, there are all kinds of risks out there. So the question is determining which risks will be exposed when venture funding becomes harder. Evans argues that companies today are much less dependent on venture funding because they are more capital efficient and thus much closer to breakeven. I think it depends on what the company is trying to achieve.

Take Uber as an example. They have raised a lot of money, but if the venture spigot turns off tomorrow, they already have a massive business. And it is geographically hedged – meaning that even if the Bay Area economy tanks their business in other parts of the world will likely not be affected. By contrast, there are a lot of developer-focused companies out there: dev tools, ad networks, etc. When it becomes hard for app developers to raise venture money, they will cut back on all of these things.

I think this area will be one of the big victims of Rule #3 from above – the Law of Unexpected Consequences. For instance, one of the more interesting areas today is ‘Big Data’. There are a lot of really interesting companies out there building Big Data applications, platforms and analytics. However, dig a little deeper, and it quickly becomes clear that the biggest consumers of big datasets, and thus Big Data tools, are ad networks. We could easily see some very promising Big Data companies disappear because they are much more levered to these sorts of vulnerable sub-sectors.

There are also businesses which do not scale in a linear fashion. For instance, enterprise software companies need to build up a large sales force, find reference customers and close very complex deals. These companies need to go a couple years wholly dependent on venture funding in order to reach critical mass. Admittedly, conditions are much easier today than they were even five years ago. There is a lot more flexibility in enterprise software adoption patterns. Nonetheless, it should be clear that losing venture funding is going to be harder for some types of companies than others.

Let me conclude by repeating that I do not want to come across as alarmist. I have no idea when the business cycle will turn. And it is clear that many parts of the industry will be able to escape unscathed. Nonetheless, I will stand by my statements above. Things will change. It may or may not be a catastrophe. But there will be a lot of unexpected casualties along the way.

Fast Fashion in Chips? Mediatek beats Qualcomm

The Wall Street Journal had a great profile of Indian handset company Micromax yesterday. It was one of those articles I love – comparing one company’s model to that of another in a totally different industry and making some nice conclusion about a big theme.

The headline says it all “India’s Micromax Churns out Phones Like Fast Fashion”. The point being that Micromax is taking cues from clothing retailers that iterate quickly through product lines. The Economist, the Journal and many others have written extensively about the supply chain that enables stores like H&M or Uniqlo to churn out a new item from concept to shelves in 30 days.

So the article on Micromax opens up the interesting question – how does Micromax come out with 30 phone models a year? It turns out that the answer says a lot about the handset industry.

First, Micromax does not really hold the record for phone models produced in a single year. I think Samsung did 50 models in 2013. But Samsung is orders of magnitudes larger than Micromax. So there is clearly something about Micromax that lets it be much more efficient. And it is worth keeping a bit of history in mind. Just as Micromax seems to be gaining on Samsung’s share in India, Samsung itself used the same tricks ten years ago to beat out first Motorola and then Nokia. Up until the very end, Motorola struggled to release new phones in a timely manner. I remember times when Motorola’s entire stock price depended on whether or not they would ship certain flagship models in time for the Holidays. Remember the U700? No? Well it did NOT ship on time.

It should surprise no one that Micromax relies a lot of the Taiwan/Shenzhen electronics complex to accomplish what it does. Micromax seems to take full use of that ecosystem. In particular, they seem adept at managing phones utilizing all the silicon options available. This is actually very hard to do efficiently, so Micromax has probably created something a bit differentiated here. But at the heart of the ability to churn out phones quickly sits the main chip in a phone – the baseband.

Micromax works with multiple baseband and OS vendors, but most of Micromax’s competitors in India and China, work with just one OS – Android, and only two baseband vendors – Mediatek and Qualcomm. And when you dig down, only Mediatek can really provide the ‘Fast Fashion’ adaptability that the article highlights.

Funny as it sounds, Fast Fashion trends apply almost as much to chips as they do to mobile phones. Admittedly, no one can turn out a new chip design in 30 days, but one of the big drivers of Meditaek’s success has been the speed with which it does bring out new designs.

I know that I lose a lot of readers whenever I talk about chips, but I think that too much commentary in the Industry focuses on consumer devices without regard to the enabling technologies that come packed inside. Micromax can attempt to be a Fast Fashion company because it can turn to Mediatek to come out with new chips at a steady pace.

I used to spend a lot of time asking small handset companies in China when would they start using Qualcomm chips instead of Mediatek. And for years, the answer has been the same. Almost every one of them has considered using Qualcomm, or even designed a model or two around them. But they always return to Mediatek for the bulk of their volume.

This is not because of price. Qualcomm has been the price leader in China for a several years already. And it is not because of Qualcomm’s licensing regime, which has been getting easier (and leakier) for years. The real source of loyalty to Mediatek is that company’s ability to respond to customer demands. I have heard this time and again. Even relatively small customers can get firmware updates and new features almost by request. Mediatek has a giant force of sales support engineers working in China (and probably India now as well). And more importantly, this group has the ability to get headquarters to change chip designs. And quickly too.

By contrast, the view of Qualcomm from Asia is the opposite. The OEMs and ODMs will all concede that Qualcomm usually has better products, but they say the company is too rigid. All changes have to be made at headquarters in San Diego. Even the team in Santa Clara, where Qualcomm has a massive presence, struggles to get the design changes they need. While Qualcomm now has a massive team in South China, it has done little to change the competitive perception versus Mediatek.

Maybe this is a deliberate strategy, and Qualcomm’s Centralized Planning department has some strategic benefits that I cannot see. However, as the centers of phone design and demand shift further to Asia, this strikes me as an area where Mediatek has built up an important advantage.

A Practical Guide to IPOs – Chapter 4C – A Few Words on Inventives

I feel that I have to drag out this post a little bit. One of the key messages I want to convey in this series is that as private companies become public ones, they undergo a dramatic transition in their shareholder base. Put simply, companies trade their venture backers for public, Institutional Investors.

These are two, very different groups with very different outlooks. Management teams need to keep in mind that managing the expectations of these two groups requires two very different frameworks.

When it comes to the topic of going public and an IPO, things get even more confusing. In many ways, the typical time horizons of these two groups get inverted. Venture investors, who typically have a very long-term time horizon covering many years, become much more short-term focused. They want the IPO, and many will see it as the end of their journey with the company. It is human nature to get less impatient the closer we come to the end of a trip. And VCs are no different. As patient and worldly as they can be, they have many incentives for wanting the IPO to come soon. By contrast, public market investors are getting ready to start a long-term journey. They may only hold company stock for a quick flip during the IPO, but a well-run company will draw their interest back, again and again. The goal of investor outreach during the IPO is to lay the foundation for long-term investor interest. Company’s behavior during the IPO will go a long way in determining how the Street treats that company.

It should be clear, that during the IPO, these two investor groups have very different objectives. There is no judgment in that statement. I am not saying that VCs are bad or greedy, nor am I saying that public market investors are easy, fun-loving folks. But the reality is that the two groups want very different things.

Management teams need to recognize this and balance the needs of both groups accordingly.

This is part of Chapter 4 in my series “A Practical Guide to IPOs” – you can find the beginning of Chapter 4 here and the start of the series here.

IPO Series #4B – Cast of Characters – Investors

KEY LESSON: It helps to understand investors’ individual time horizons, incentives and career perspectives. Or you should get help with your Investor Relations strategy.

Now we get to the meat of the process. A company’s investor base is a very important determinant of a company’s future stock prospects. This section took me several drafts to write.

In this series, I am looking at professional money managers, people who get paid to manage the investments of others. (Retail investors are a whole other topic that I will get to in a later chapter.) These money managers, often called Institutional Investors, are the people who manage the world’s retirement assets. At first, I tried to lay out all the types of investment funds there are:

  • Mutual funds or long-only
  • Hedge funds (i.e. funds that can short stocks)
  • Pension Funds
  • Investment Bank Proprietary Desks
  • Family Offices and High Net Worth advisers
  • Sovereign Funds
  • High Frequency Traders
  • Index, Quant and Exchange-Traded Funds

But this approach gets very blurry very quickly. For example, many investment managers run long-only funds for clients but also maintain internal hedge funds for themselves or a select group of clients.

Instead, I think management teams need to understand a few key facts about who their new business partners are.

First, fund managers each have their own time horizons. Typically, long-only investors can hold a position for years in a stock. While hedge funds hold for shorter periods, months or days. That being said, hedge funds may hold a stock for a short period, they can still follow it for years, repeatedly trading in and out of positions.

Second, holding periods are closely tied to incentive structures. This gets very complicated. The simple view is that many hedge funds get measured every month, while long-only funds get measured quarterly, annually and over multi-year horizons. But there is a lot of nuance to this.

Third, investors are individuals and they care about their personal career trajectories. Put simply, there are really two levels of investors – analysts and portfolio managers. Analysts are the more junior of the two, and hope to get promoted to portfolio mangers. They need to make smart investment recommendations over a long period. This is complicated by the fact that they also have to convince their portfolio managers to actually follow their recommendations. They typically look at a smaller number of investments than their bosses, but get much deeper into the details. Management teams often und up knowing many analysts well, seeing them many times over the years without ever meeting their portfolio manager bosses.

An analysts’s career path is hard to predict because often their immediate progress is determined by the very idiosyncratic relationships they have with their portfolio managers. I mention this, because companies will often find that a very receptive analyst, who meets with the company many times over the years, but never actually invests in that company. Often, this stems from the analyst’s portfolio manager not wanting to follow the investment advice. This can be frustrating for everyone involved.

Despite being the ‘boss’ Portfolio Managers (PM’s) have a very stressful job. They have to balance many risks and are constantly being measured by the markets and their own investors. Usually, the most important number for a PM’s career is his or her Assets Under Management (AUM). In one way or another, their compensation is tied pretty closely to the amount of money they manage. This is an incredibly competitive industry, so PM’s end up getting measured constantly. They get measured against some benchmark (for example, the S&P 500 for many mutual fund managers) or in terms of absolute return of their funds (more typical for hedge fund managers). Good results for their funds tend to attract more funds for them to manage. Mutual fund managers track fund flows into their funds on a daily basis. Hedge fund managers periodically raise new funds (similar to Venture Funds), and a good year means that raising the next fund can be much easier.

The one common theme throughout this is timing matters. The trading year has numerous key milestones which matter immensely to investors. Let me give an example to make this clear. Let’s say a newly public company has done a good job of attracting investors during its IPO roadshow. Everyone likes the management team and the stock. Then reality rears its head and the company misses its earnings numbers. If that miss takes place nine months after the IPO, and they announce the miss during the summer, there will be some grumbling, but probably no hard feelings. On the other hand, if the company announces the miss a month after the IPO, in the last week of December, then this will likely result in several investors having to report weaker annual returns to their own shareholders. And since investor compensation is heavily weighted to year-end bonuses, it is very likely that the company has just made a lot of enemies. As rational as the market is, it is still composed of individuals.

The most important thing for management teams to remember is that there is no such thing as the perfect investor. Many management teams express a distaste for dealing with hedge funds. “We only talk to long-only funds” is a common refrain I hear. This is a big mistake, especially for smaller companies (and by small, I mean market caps of less than $10 billion).

Management teams need to engage with almost all types of investors. First, this is a small industry, and investors talk to each other. A hedge fund analyst, may be playing squash with the mutual fund manager right after you meet her, or the day after that she may be running a giant long-only fund herself. More importantly, hedge funds trade a lot, than means they supply the liquidity which the long-only funds require to hold a position. There is a weird kind of symbiosis taking place here. Companies want long-only investors, but those investors want to see a lot of hedge fund activity before they take a sizable stake.

In the end, the best strategy is to preach where the choir appreciates the sermon. Management teams should court investors who show interest and who have done their homework. This is hard to determine during the IPO road show, because no one knows the story yet, it is new to everyone. But within a few months, it will be clear who the repeat visitors are. With time, companies need to develop a coherent investor relations (IR) strategy to make sure the company is reaching the right mix of investors. This takes some expertise (which is a not-so-subtle pitch for my consulting services).

Finally, keep in mind that any IR strategy will have two phases. One for the IPO process and one for the rest of the company’s life. We will return to the latter topic in a later post. As for the IPO IR strategy, that will in large part be determined for the company by its bankers, which we will address in the next post.

This is Chapter 4 of my series “A Practical Guide to IPOs”, you can find Chapter 1 here and the first part of Chapter 4 here

IPO Series – Chapter 4 – The Cast of Characters

IPO Series #4 – The Cast of Characters – A Lesson in Incentives

KEY LESSON: Every external  party in the IPO has a different time horizon. Know who will stick around and who will leave right after the bell rings.

For most companies, the IPO marks a major transition in shareholders. The investors who companies have dealt with for years are going to start exiting, and a whole new horde of barbarians investors is about to coming pouring through the gates.  

I have found that companies spend a huge amount of time and energy picking their bankers and lawyers and auditors for the IPO, but they spend very little time getting to understand investors. The problem with this is that the day after the IPO, all the bankers and lawyers go away (the auditors stick around, but you can’t have it all). Yet the vast majority of the IPO preparation is spent with just those people. So companies are spending too much effort on the constituents that will be around the least.

So in this chapter, I want to walk through the players in the IPO process. And most importantly, I want to look at each groups’ incentives and time horizons. These matter a lot, but this description is going to poke some tricky truths. I have kept things as non-cynical as possible, but many people may extrapolate from these comments and find a bit of controversy. That is not my intention. Remember, if the IPO process at times seems nonsensical, I think we can all agree that there is one party responsible for that – the Federal Government.

 I present the list below roughly in the order in which management teams meet them.

The Lawyers – My thinking on attorneys has changed a lot in recent years. Having a good corporate lawyer is one of the most important resources a management team can have. They know a lot, they are legally bound to be your most zealot advocate. Well-chosen attorneys will provide counsel on many topics that are beyond the scope of any CEO to do on their own. That being said, securities lawyers are a special niche case of attorneys. They will bill a lot. They will ask you an exhausting amount of questions. They will probe every dark cavity of your operations. They will require you to perform things that seem like unnatural acts. Remember, they are not looking to make your life difficult. They are there to help you avoid the things that will make your life truly difficult. And keep in mind, that after the IPO, you can go back to relying on your corporate lawyer.

The Auditors – The audit regime of being public is one of those unwieldy realities of today’s public markets. The ‘reforms’ that came out of the 1990’s .com scandals (e.g. SarBox) are on the border of being punitive. They give the auditors tremendous leverage over a company’s operations. They will also remain with long past the IPO. For most companies, the audit costs of being public are something like a $1 million a year, and up. Like I said, blame the government. Many of the SarBox rules feel like a form of taxation paid through the auditors rather than the IRS. Just keep in mind that they are there to help, and often having a rigorous audit and control regime in place provides a great layer of insight into a business.

The Bankers – Bankers have a bad reputation. They are seen as mercenaries (remember, no cynicism here), who will move from one transaction to the next. So be it. That is their job. There are roughly a dozen major (aka ‘bulge bracket’) investment banks out there and a 30 or so regional or specialty brokers. In a future chapter, I will explore how to pick them. For the most part, a company will have six or seven serve as underwriters on the IPO.. After that, most companies will only engage with one of those banks ever again. A banker’s job, especially IPO bankers, is to sell a company’s shares to the public markets. Management teams want their bankers to have lots of deals under their belt so that they get good at it. The fact that they will move on immediately afterwards to someone else is a positive, but be prepared for this. Each bank will have a ‘relationship’ banker who can become a trusted advisor to the company. But there will also be dozens of other bank employees who know little about the company or industry. Do not be put off by their brisk nature or the fact that they are a great friend today, who forgets you tomorrow.

Research Analysts – I am now four chapters into this and just now getting to the role I know best. Analysts are employees of the investment banks, but they have an important hybrid role. They are a bridge between the world of being private and the world of being public. Handled well, they are an important megaphone for getting the company’s story out in a way that it can shape. Once the IPO happens, companies lose much control of their story. The analysts will be the last opportunity to entirely control a company’s message. Analysts have to walk a tightrope. They want to support their bankers, but they also want to protect their reputation among investors. They are legally divided from their bankers, but at some level both sides have the same CEO. The bankers can generate tens of millions in fees, analysts generate hundreds of thousands or a few million in brokerage commissions. On the other hand, analysts only do a small number of IPOs every year. The rest of the time they have to get in front of investors and defend their ideas. Reputations matter a lot to them.

Management teams should pick bankers based on the analyst team because the analysts are going to be around, following the story for years. But there are also dozens of other analysts out there. The first group that ‘covers’ a stock will help shape the company’s first impression on Wall Street, but with time other analysts will likely join the fold.

I am now going to start looking closely at incentives. All the groups listed above get paid only when there is an IPO transaction. At some level, this is going to bias even the best of them to get the IPO out the door. With analysts, we start to see groups who value something very different. Analysts care about two things. First, they do not want to be embarrassed. If you promise them something and then do the opposite in a week, they end up looking bad. The key lesson of this chapter is that expectations matter, so be very careful when setting them. Later in the series I will devote a whole chapter to this topic. Secondly, analysts want access. They want access to information, so that they can publish notes that do not sound like the other 10 or 20 analysts covering a stock. This is not the same as inside information (that really does them no good). They will come with questions about products and operations and customers. Their lifeblood is information, manage closely how you dole it out to them. But they also want access to you. They are going to invite you to non-deal roadshows and to attend conferences. Public investors pay them to provide this access. Be prepared for this. Analysts can be a great resource in getting a message out, but the price for that resource will largely be measured in management’s time.

Salespeople aka Brokers – The key audience for the analyst are their sales people, or brokers. Salespeople sit on the cash register for the brokerage operations, and pay the analysts’ salary. Their job is to get in front of investors and to manage the brokers’ relationships with these clients. By definition they are not going to be experts in your stock. The analysts’ job is to provide the salesforce with enough information that they can make a concise presentation to their clients about a pending IPO. This is not an easy job, filled with as much logistics as actual salesmanship. Typically, company management teams do not meet salespeople until fairly late in the process. I always found this strange. Companies should know what a salesforce is capable of when picking their underwrites. Some sales teams are very specialized, focussed on a particular region or investor class. One very well-known bank has a sales force that actually has a very poor reputation among institutional investors, but can execute any IPO by bringing in their high net-worth clients. This is usually a bad idea for the company, but one that is only realized when it is too late.

Sales people are paid for trading volume and client (i.e. investor) relationships. They are going to ask dumb questions. They are going to make mistakes about some very key points about a company. Set those aside, because they are a very important resource in getting the story out there. At the very least, like all sales people, they are usually a good bunch to spend time with. Get to know about them as early in the process as possible. And keep in mind that they will also be around long after the IPO. They will remember a good or bad process, and will have a definite impression of a company’s management team, and they will communicate that bias to their clients – the investors.

In the next chapter, I will take an in-depth look at all the types of public market investors that a management team may encounter. 
This is the fourth chapter in my Series “A Practical Guide to IPOs”. The sereies began here and you can find the previous chapter here.  

IPO Series Chapter 3 – Reasons to Not Go Public

KEY LESSON: The IPO involves changing one group of business partners for another entirely different, largely unknown group

As I noted in my last post, most companies have little choice but to eventually consider going public. So this chapter is really more about reasons to delay going public, and knowing what lies ahead.

The IPO process is grueling and expensive. It distracts management from actually running the business. All too often, it also creates distortions in business plans. For example, one company I helped take public had to curtail R&D efforts in a bid to reduce costs and gin up earnings figures (EPS). Come to think of it, many companies do this. In the example I am thinking of, the company actually fell behind and lost a key customer as a direct result of that R&D starving.

So it is important for companies to keep a clear set of priorities. Do not alter your business in any real way to prepare for going public. If that means some metric is going to be sup-optimal for IPO investors, then delay the IPO. Once you are public, those distortions will eventually come out, and that is far worse.

There will be some inevitable changes to company culture. Accounting systems will have to get much tighter. This is not entirely a bad thing, as it gives management teams some clearer data about their operations. Management will also have to communicate less to employees. For many start-ups accustomed to very flat management hierarchies, this is a big disappointment. Many companies resist the IPO because of the damage it does to company culture.

Another big problem is employee distraction. The IPO becomes an end goal. I noted in the last post, that for the very near term, the goal of an IPO is very motivating. But if it drags on for a long time, employees get very frustrated with the pending IPO starting to feel like some existential drama like “Waiting for Godot”.

Often, management teams will feel like they do not need the things an IPO brings. Today’s start-ups are often built to be lean and thus have ample cash flow to keep operations going. Expansion capital is readily available from private source like VCs. (Of course, this is just a fleeting phenomenon. I can say with a lot of certainty, that some day in the near-ish future, venture capital will no longer be so easy to tap.)

Going public is also expensive. Bankers, accountants and lawyers (always the lawyers) are going to take millions from the deal. I will not begrudge them their fees, but for companies with very low corporate overhead, these bills can come as a big pill to swallow.

The preparation for the IPO will also lay business realities out naked for all to see. There is nothing as sobering as reading about a hot start-up’s business as filtered through SEC filings. Before these come out, the company’s marketing team can shape its message. Today’s tech press makes celebrities out of companies and start-up CEOs. Before the IPO filings come, every business can be described in glowing terms. Once committed to the S-1, nothing glows anymore. And this is to say nothing about what competitors gain from seeing actual numbers.

Most importantly, the IPO process means changing one set of shareholders for a very different set. The new investors are a big unknown, they have generally had no interaction with the private company until days before the IPO. Banks have started to take their IPO candidates out to see investors a year or two ahead of prospective IPOs to inoculate them a bit, but that only goes so far. Management teams have often had years to work with their venture investors. Plenty of time to get them comfortable with the story and the company’s big vision. The new investors are just that – new. They are not familiar with the story, focus more on the numbers than the big vision, and have a very different set of expectations.

In the end, I think the biggest reason management teams have for not going public is simple fear. I am not calling anyone a coward. Being public is a headache, and there is good reason to be afraid. One company I worked with pulled the plug on an IPO, settling instead for a sale to a competitor. The sale price was probably 50% of what they would have realized in an IPO. The CEO appears to have made that decision days after meting with us research analysts for the first time. I think that in his heart of hearts, he knew that he did not want to run a public company.

As you prepare to go public, have no illusions about this. You are entering into unknown territory, and the locals are not friendly.

This is Chapter 3 in my ongoing series on the IPO Process. You can find Chapter 1 here, and Chapter 2 here.

IPO Series Chapter 2 – Why Go Public?

Key Lesson: At some point, going public becomes inevitable

(This is Chapter Two in My IPO Series. You can find Chapter One here.)

There are textbooks reasons for going public:

  • Access to capital
  • Liquidity for equity-paid employees, rewarding years of hard work
  • Creation of a currency for acquisitions and attracting talent
  • New credibility with customers and suppliers

You see this in MBA Corporate Finance 101 textbooks. And the same professor probably mentions the status of being public. That does not get bandied about as much anymore. That status has been diminished by a variety of factors (which I will get into for the next post), but there are still plenty of good reason to wade into the IPO process.

When I speak to private company executives nowadays, the chief appeal is really the ability to use stock as a way to attract talent. They probably want the acquisition currency too, but that is less common. Having public stock does make it easier for prospective employees to get comfortable coming on board.

However, the IPO as a capital-raising event is no longer as important as it once was. For the time being, the world is awash in venture capital funds. Any company that can go public can also raise a late-stage venture round. Still, once a company is public and filed, there is no question that its access to capital gets a lot simpler.

Beyond all these textbook examples, there are some other very good reasons to go public.

First, it is a fantastic marketing opportunity. IPOs are big, well-understood events that the media can write about easily, complete with shots of the management team on the floor of the stock exchange. Many companies have used the IPO as the cornerstone of broader mass market media campaigns which are especially useful to companies which need big audiences. Going public puts web sites into the mainstream eye. It is not a cure-all, but it is a pretty good growth hacking tool to have in a company’s belt. The same is true of companies that care less about consumers and more about enterprises, an IPO remains an important public milestone.

Another reason is that it can become a goal around which to organize and motivate teams. Now, the whole point of my series is that the IPO is just a step in the life of your company and should not overly distract from the long-term evolution of that business. Nonetheless, as a near-term event it can push teams to accomplish great things. So long as you do not let it distract from or distort the company’s strategic plans, reaching the IPO will become something that is celebrated internally.

A third, quieter reason is that it can be very good for management teams. It is an important item to have on a resume. Beyond that, being a public company CEO is probably one of the greatest jobs out there. You still have to deal with your board, but with time that board will become more manageable. This is shaky corporate governance ground, so no one really discusses it, but that does not diminish the underlying reality. Instead of having company equity concentrated in a small number of holders (often VCs), your equity is held broadly. As I will discuss in later chapters, managing that large body can be much more manageable than dealing with a venture-led board.

For many companies, going public may not be optimal, and the end goal is really a sale to someone larger. In these cases, the discipline of preparing to go public is still incredibly useful. Many companies file S-1s in preparation of going public only to sell out before the IPO. Having an IPO in the works is a tremendous bargaining chip. It gives the private company a credible alternative to a low-bid, allowing them to walk away if needed. And having the bankers in to give you an estimated IPO valuation gives a good benchmark when you go into any negotiation.

But setting aside everything else, there is one good reason above all others to take your company public – Your Board wants you to do it.

Eventually, they will get their way. This may not apply to your family-owned business, or those rare cases of largely bootstrapped, self-financed companies, but for everyone else that is the reality. A venture backed board has its own shareholders or Limited Partners. The VCs eventually need to pay back their own investors.Today, many venture investors argue that they can be more patient than public market investors. Maybe this is true in some regards, but eventually investment funds close.

Going public can provide many benefits to a company. But for most companies, there is really little choice in the end.

Coming up next: Chapter 3 – “Reasons for Not Going Public”


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