IPOs?

IPOs?

FRIDAY, OCTOBER 2, 2009


Another misconception among entrepreneurs involves the IPO which is often the ultimate goal of all parties involved. In the past 10 years or so, many VC funds have gotten large enough to hold and finance most private companies without the need for an IPO. If you are a stock investor you should know that many IPOs come at a time when the VC firm has milked the income growth out of a company and now just wants to unload it, when the private owners want to cash out, or when either party wants to throw a Hail Mary. Obviously, this is not always the case. But if you have been involved with or closely followed an IPO, you know that the underwriting bank gets 7% of the entire capitalization, the owners get a bunch of stock they can sell on the secondary market, and a select few unattached rich investors get richer. And the stock holders? Well, the stock typically enjoys a "run-up" of an average of 105 days, and then within ten-years about 63% of them are gone (source)

"Doesn't that mean I get rich?  What's wrong with that?" you say.  Nothing at all.  If your company's stock can hang on during the time you're restricted on selling your shares-- typically 6 months-- you'll do well.  The problem is now, in 2009, the IPO market has evaporated due to the reasons I mentioned earlier.  Also, the macro environment for high-tech has changed.  There just aren't as many easy opportunities as there used to be.  So, if you're going to commit your time and effort to the company in the hopes of an IPO you should be aware that the recent past is not a good indication of what's in store for you for years to come.  That's especially true if you're focusing your efforts on the highly saturated and maturing Internet/Software industry as new industries, such as Green-Tech have become the new focus.  As an alternative, you can always consider growing your company organically (with revenue growth) and keeping it private. 

The VC market has likely been irrevocably damaged. Part of the reason is the massive deleveraging of our financial system as a whole. Banks, hedge funds, and other investment entities were highly leveraged (some European banks were leveraged 35:1 when historically 9:1 to 12:1 is acceptable). When the dust settles in a year or two, the massive influx of VC investor money since globalization took hold in the early 90s will likely slow considerably-- probably by at least half.  Expect that $29 billion VC market to be $15 billion and 3000 new companies to be 2000 smaller and less revenue aggressive companies. 

That's not necessarily a bad thing. I have a theory. When people talk about 'leveraged money' they are really talking about someone else's money. This holds true even for banks who literally create money through fractional-reserve banking (see Federal Reserve).   When you take out a loan, the bank asks the government to create more digital money so that they can loan it to you. I know that sounds ridiculous, but that's how it works. Leveraged money is fun to play with, especially when it's non-recourse, but 'my money' is not. When 'my money' is involved, all of a sudden I get serious.  As banks de-leverage, the highly risky VC market will appear less attractive which will force the VC funds to focus on more conservative companies with more realistic outlooks.  

In the coming years, look for trends in microfunds and accelerators as state and city governments finally realize that cleaner, technology, biotech and more sophisticated intellectual-property-driven companies hold the keys to drawing employees to an area (and thus tax revenues).
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