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.