So you want to throw an IPO? Part 4 – Pick your liquidity

This is Part 4 of my ongoing examination of the IPO Process, you can start at Part 1 or last week’s Part 3.

In that last post, I went through some of the reasons arguing in favor of going public. But of all the companies that get venture funding, only a small percentage actually end up going public. A far more likely outcome is that you sell your company to another, larger company. Part of my motivation for writing this series is to help management teams evaluate these options – sell or hold out for an IPO? Even if you do not think your company will go public (or you do not want to be a public company CEO) it is important to understand the IPO process, because it can be a very powerful negotiating tool. If you decide to sell your company to someone larger, it helps to understand the valuation you could potentially receive as a public company. I will discuss valuation in a later post, but in some cases a public market valuation can be higher, and it helps to have that in your pocket when dealing with a larger entity.

The drawback of this approach is that with any negotiation you have to be prepared for the other side to call your bluff. “You think the public markets will give you a $6 billion valuation? Good luck.” So it is important to think through what is at stake for selling yourself to a larger company.

The big advantage of a sale is that there is much less risk involved. Money today is worth more than money in the future. The bankers will give you a net present value (NPV) calculation of what your future public market valuation would be so you can compare it to the offer in front of you. But that NPV does not fully the risk of capturing that potential future valuation. A lot can change between now and some future IPO. There is the execution risk inherent in your business, but there is also the risk that equity markets may shut down to IPOs in the future. Right now the “IPO Window” appears to be wide open, but it has only be open for two years, prior to that we faced a nearly five your drought of IPOs. And someday we will face another shutdown. That’s just the way the equity markets work. (Again, a topic for another day.)

So generally speaking, someone offering to buy your company today is much less risky than an IPO, but it is not riskless. Trawl the blogs for a while and you will find many posts from CEOs who had agreements to sell their company to someone larger, only to find that larger party pull out at the last second. Even worse, there are plenty of stories of big companies conducting full due diligence on a small private company largely for the purpose of decoding the smaller company’s secrets.

Of course, selling yourself today has other drawbacks. As CEO you enjoy considerable personal freedom. It may not feel like it, but you are the boss and you call the shots. You have considerable freedom to make the decisions based on your own judgment. Sell your company, and you become a cog in a far bigger machine. In many, many cases, the acquiring company makes all kinds of promises about giving you freedom and independence. But in almost all of those cases, reality eventually intervenes. The larger company may be public, and when it faces some quarterly problem decides to use your ‘independent’ division to reduce costs. This happens far more often than anyone wants to talk about.

Once you join a larger company, you do get offload some onerous duties. You are no longer responsible for making all kinds of administrative decisions. You do not have to manage the office supplies, or HR policy, or have to choose the site of the company Holiday Party. Or whatever task you least enjoy. Many private company CEOs look at the infrastructure of a larger company and think that joining that machine will free up time. There is some truth to that, but chances are the time you would spend on those un-enjoyable tasks is replaced by equally onerous burdens like corporate bureaucracies and meetings about meetings.

Similarly, joining a larger company may give you greater resources to accomplish your vision. This seems to be the case with Nest’s sale to Google. Many vendors, especially in hardware, will want to see significant cash reserves in the bank before doing business with a company. Sitting inside a large, public company negates many of those hassles.

Ultimately, it comes down to personal choice. I have seen many CEOs prepare their IPO – hire the bankers, do the audits, undergo due diligence, and prepare the roadshow only to sell their company at the eleventh hour. Faced with the reality of going public, many management teams balk at the changes required and choose the safer option. Do you want to ring the bell on the stock exchange floor, go to investor conferences and appear on CNBC? Or would you be happier as Senior Vice President of New Technologies inside some larger company. And deep in your heart of hearts, do you really believe that your company has the wherewithal to transform itself into something larger? In many cases, the answer to that question is No. There is no shame in that. Better to sell your company now than to realize your problem six months after the IPO.

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