Why an Early IPO is in the Best Interest of Each and Every Founder
The relationship between VCs and startups changed, but not for the best of the entire ecosystem. Nevertheless, there’s a way to restore the order of things and make everyone happy.
Over the last 30 years, startups’ way of accessing capital has undergone radical but massive change. Before the New Economy bubble, access to VC money was complex and had a lot of constraints. In the early days of venture capital, the partnership between startups and investors was a different story compared to today’s standard.
When Intel was created in 1968 by Robert Noyce and Gordon Moore, they had to raise capital to set up offices and the manufacturing facility. The $2.5 million Intel required came from the venture capitalist Arthur Rock and an additional $10,000 from each of the founders, Noyce and Moore, in exchange for 50% ownership of the company. When the company went public three years later, in 1971, it had an approximately $23.5 million valuation. The IPO raised about $6.8 million.
When, in a rare interview, Ron Conway told the story of Altos Computer Systems — a company he co-founded — he remarked that to access VC capital, you had to be profitable and not just growing:
Back in the 70s, in order to get venture capital, your company had to be high-growth and profitable. These conditions were required to qualify.
Altos was created in 1977 and listed on NASDAQ five years later, raising $59 million from the IPO.
In 1976, when Apple Computers was incorporated, the company raised $250,000 from Mike Markkula for 33.33% of the company. Apple Computers didn’t raise any other capital from VCs before the IPO in December 1980. They only secured a $250,000 loan from Bank of America in 1977. This loan, combined with the funds from Mike Markkula and revenue generated from the sales of Apple I and Apple II computers, helped sustain the company’s growth leading up to its IPO in 1980. At the time of the listing, Apple’s market capitalization was around $1.8 billion.
Amazon, founded in 1994 by Jeff Bezos, started with a $10,000 investment by the founder and $100,000 from friends and family. After about a year, they raised their first round from Kleiner Perkins and others. By the time of the IPO, three years later, in 1997, they had secured around $62 million from VCs. When they decided to go public to sustain Amazon’s aggressive expansion plans, the company raised approximately $54 million at a valuation of about $438 million.
Private capital was crucial for the success of these companies, but investors’ exit strategy came primarily from the IPO, which occurred a few years after their initial investment.
It was probably with America Online — founded in 1990 — and Yahoo! — founded in 1994 — that the tidal wave of Internet M&A began. The former acquired Compuserve in 1998 and Netscape Communications in 1999. The latter acquired Net Controls, Viaweb, Yoyodyne Entertainment, Broadcast.com, and GeoCities a few years after its incorporation.
Those were the early days of the Internet, and since then, the M&A trend become a very attractive way to get a liquidity event. Over the last 20 years, the venture capital market has attracted more and more players with bigger and bigger funds until billion-dollar multi-stage funds became the new normal. With billions of dollars under the same roof, VCs could finance startup growth, avoiding the public market for years after the first round.
The pivotal shift that made it possible for startups to stay private for 10, 12, or even 15 years seemed to make everyone happy: founders, investors, and LPs. What I can’t help but wonder is if the strategy of “raising more and staying private” truly benefits the founders.
Over the past decade, the private market has become increasingly competitive with an impressive influx of funding deployed into the startup industry. According to data from the National Venture Capital Association (NVCA) and PitchBook, in just ten years, from 2010 to 2020, the total amount of capital invested by VCs in the United States grew more than 7x, while the number of deals increased by almost 3.7x — so the deal size nearly doubled.
It should be evident by now how there has been a significant transformation over the years, with a substantial increase in the last fifteen years. The VC market evolved while it has attracted more and more interest, but not every evolution it went through has been for the good of startup founders.
Such abundant capital in the private market and much bigger funds to deploy have given startups more options than the IPO: stay private, grow more, and aim for a spectacular exit — in theory. That worked during the bull markets of the last fifteen years, but things have changed a lot in the last two when the public market cooled down, and the private one followed abruptly.
Today, access to capital is much more complicated, which results in lower valuations and fewer deals closed. The IPO market dramatically reduced its impact on liquidity for investors, and everyone is hoping that M&As will come to save the day.
The fact is that it won’t! National regulators in the US, UK, and Europe became more enthusiastic in their role of surveillance of the market to avoid the creation of unfair advantages, and “more than $70 billion worth of planned acquisitions by American technology companies have not come to fruition” in recent years, accordingly to Crunchbase. Many deals failed because antitrust opposed them, and, at the same time, acquirers got tired and discouraged by how complicated the acquisition process became.
One factor affecting M&A problems is the size of the acquisition, and that’s a direct consequence of startups staying private for too long and becoming too big. Things can only get worse in the coming years; all the stakeholders — founders, employees, and VCs — want liquidity events to happen; otherwise, the market will stagnate, and the entire ecosystem will suffer.
The fun fact is that the range of possible solutions to this issue should be clear to anyone in this business:
Option #1: Startups should know that, among all the options they have to repay investors, the IPO is the best one for their business.
Option #2: Startup founders should consider looking for potential acquirers earlier in their journey. Relying on an M&A market when your company is a decacorn is too risky, and antitrust regulations could hinder their plans.
All the other potential situations are significantly more intricate. You can’t give stock options to your employees and tell them they can redeem them only in 15 or 20 years. Of course, there is always the secondary market, but that is harder and works well only during bull markets. Creating companies that you won’t control after the first price round — because of the VC money you raised — and not having a clear exit strategy in 5 to 6 years from its foundation is not good for founders or employees. This was not the case when the Internet emerged, and people began investing in its potential.
Now, ask yourself why things have changed for the worse in a few decades. And more importantly, why are founders part of this game that is not in their interest?
There are multiple reasons, most of which can be traced back to a lack of clear understanding on the founder’s side about why they decided to create a startup in the first place.
At the initial stages, a startup has access to private capital because investors have a gut feeling that the specific team building that product in that market could generate massive returns quickly. In exchange for that, founders accept they won’t be able to decide the future of their company by themselves, like any other entrepreneur. Besides, the more capital they raise, the more they get diluted. The longer the time that separates them from the liquidity event, the more complicated the journey will become. And the exit is something that investors need because they have to return capital to their LPs.
Not all liquidity events are so convenient for founders. Some require them to sell their company to an acquirer and become employees, while others don’t. If the company chooses to go public, investors can exit the business, and founders can regain a fair share of control. Of course, being a public company has its share of burdens and expectations by the market, but no more Preferred Stocks and privileged shareholders. Everyone becomes a Common Stockholder. This is the way to get your company back on track and make everyone happy!
People who are building the company of their dreams don’t want to lose it, and for sure, they don’t want to see their realities fall apart after they put so much effort into making them. I think this is something we can all agree about. And that’s why I’m having difficulties understanding what has happened in the last two decades. Why wait until it’s too late to pursue M&A options or stay in the private market longer than necessary, risking losing the game through a painful process? Going public should be just the beginning of the journey. Looking at successful companies’ performance in the public market, we can clearly see that so much value creation happens after the IPO. If you are a founder and aim to create the next Amazon, Microsoft, or NVidia, you want to keep it for yourself and make it a long-lasting company. The best recipe to get your company back is to raise the minimum amount of capital to take it public. Keeping the startup private for a long time is a game designed in the interest of billion-dollar fund managers.
The game can change if we want. When people’s goal is to go public, their focus is on both generating revenue and achieving self-sustainability from day one. And they know when to stop raising capital or when a valuation is too much for their stage. Remember: Every mistake made due to arrogance during the process of building a company will eventually come back to us, and repeated mistakes have fatal consequences.
In Conclusion
Regarding taking your company public, there may be better strategies than delaying the IPO to chase a higher and higher valuation. That will lead to a substantial dilution of your ownership and decreased morale among your employees. Instead, focus on building a fast-growing company through revenue and profitability, avoiding the temptation to buy market share with investors’ capital. By staying committed to this goal from the outset, you can position yourself for a successful IPO when the time is right. The earlier, the better.
If you create such a company, it may be difficult to resist the temptation of accepting funding from various investors presenting attractive proposals. But if you have a clear understanding of what your actual goal is, you will respectfully decline.
My hope is that founders will use their own minds to make a thoughtful decision about when it’s time to leave the pond of private markets and drive their reality into the ocean of the public one.
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