Why The Modern IPO Burns Companies
The modern internet changed everything.
Webpages, email, and developments in computer technology opened the door for internet business ventures like America Online, Yahoo, and Netscape. But most people forget that the rise of the internet changed the way the stock market operates.
When early internet companies went public, they tended to make millionaires overnight. These stocks soared to incredible highs, piquing everyone’s interest in the internet and well-hyped IPOs. This time was famously known as the dot-com bubble, and many companies found themselves sensations overnight.
The IPO frenzy of the 90s didn’t last long. A total of 27 companies withdrew their IPO filings in 2000 due to a weak market. IPOs are on a global decline: the market was down 21 in 2018 from 2017. The costs of going public are astronomical (estimated between $1 to $1.9 million), and the return from investors wasn’t as substantial as the capital raised from VCs and angel investors. Why would they choose to be accountable to their investors with financial statements and quarterly reports if they didn’t have to?
We’re going to show you how the IPO process tends to burn companies seeking new capital.
Early private funding rounds are flawed
Most retail investors don’t know there’s a series of private funding rounds occuring before any official IPO. These rounds serve to build hype and help determine share price. VCs and angel investors provide essential capital to these companies, and stand to make great profits on IPO day. But the retail investor gets none of this same opportunity.
We think the layers of private funding rounds before an IPO have four big drawbacks.
#1: They create vanity.
The swarm of VCs, angel investors, and accredited investors who make or break a company can just as easily create a sense of hubris for a company. With all of this attention, they may get arrogant and overvalue their company.
#2: They force companies to give up control.
Every time they get help from private investors and VCs, companies slowly give up control of their own organizations. Granting these investors partial ownership in your company in exchange for early capital also means they have a say in how that money gets spent. An investor won’t always align with your goals or values, which obviously causes friction moving forward.
#3: They’re expensive and time-consuming.
Taking a company public doesn’t mean you sign up for the stock exchange and automatically appear as a new ticker symbol the next day. It’s a long and expensive procedure. That’s why many companies choose very intentionally to avoid an IPO.
Costly roadshows build hype around your company and connect you with investors, but it takes a lot of time and effort. It’s downright exhausting.
#4: They’re distracting.
It might seem like any funding is good funding, especially when you’re a startup. But private funding rounds are actually completely distracting. They divert attention away from growing an early stage company and make everything about raising money and putting on a good public face. Time spent enticing these investors is time that could be spent chasing potential clients.
Rubbing elbows with VCs and angel investors should be secondary to making sure your company has a solid infrastructure and a high-demand product or service.
The “going public” part is also tough
After the hype from the roadshow and private funding rounds, you still have to actually go public.
An IPO is an exciting time for any company, but this excitement slowly turns to stress and dread once the company sees the IPO’s true nature. Completing this exclusive process leaves a company generally vulnerable.
Companies have to release a lot of information when they go public. They need a costly team of auditors, regulators, and lawyers to make sure they’re compliant. They must also release financial statements, quarterly reports, and other disclosures for scrutiny.
IPOs clearly require a lot of time and money. Is it worth it in the end? Having the right team, a robust business plan, and solid financial understanding is just the tip of the iceberg — IPOs aren’t for everyone. If your business isn’t prepared for it, then going public can spell disaster.
In the next chapter, we’ll cover why retail investors aren’t getting the most value out of IPOs, and the other options they have for investing.