With the recent apparent successes of several startups in taking their company public (initial public offering) and raising billions of dollars, I’m hearing a groundswell of enthusiasm from new entrepreneurs to follow in their footsteps to fund their companies and become billionaires overnight.
"If Facebook, Yelp and Twitter can do it, then why not me?"
Current IPO activity feedback seems to support their excitement. In the first quarter of 2014, the U.S. IPO market showed more activity than any other first quarter since 2000, with 64 companies raising $10.6 billion. That is more than double the number of IPOs in the first quarter of 2013. With 103 new filings during the quarter, the rest of 2014 is on track to keep up this record pace.
On the other side of the coin, new entrepreneurs seem to forget that 64 startups is a miniscule percentage of the companies seeking funding during the first quarter. According to the Small Business Administration, about 600,000 new businesses are started in the U.S. each year, and a large percentage are always looking for money.
What should an entrepreneur look for in his own startup as a reality check on his own aspirations to be a serious IPO candidate? Here is my collection of the key considerations, based on my own experience, scanning the literature and talking to experts in this domain:
1. Taking a company public is an expensive process. It will take many months and require endless amounts of time, money and energy. According to a 2012 study by PricewaterhouseCoopers, companies average $3.7 million spent directly on their IPO, in addition to underwriter fees of 5 to 7 percent of proceeds. It takes real money to find money.
2. Make sure you can effectively use a big cash infusion. There is a big difference between needing a million dollars versus $100 million, or even a billion. New stockholders will expect to see rapid growth. You better have lined up a major international expansion, some major acquisition candidates or a wealth of unfilled orders.
3. There are real ongoing costs of maintaining a public company. You will need an experienced CFO, and the best legal and accounting help to comply with the audit requirements of the Sarbanes-Oxley Act. PwC estimates that public companies incur an average of $1.5 million in annual recurring costs as a result of being public.
4. Exposure to increased liability risk. Public company executives are at civil and even criminal risk for false or misleading statements in the registration statement. In addition, officers may face liability for misrepresentations or speaking out in public and SEC reports. Executives shoulder new risks for insider trading and employment practices.
5. The public company corporate culture may not fit you and your startup. Public ownerships usually lends prestige and credibility to your sales, marketing and acquisition efforts, but it may work counter to your vision of saving the world. Most startup founders voluntarily exit or are pushed out, and the fun is gone. Analysts want escalating profits.
6. Public companies bring new expectations of benefits. If you want to give stock options, or have already been giving them, employees will love the liquidity and the thought of selling shares for a profit. On the other hand, “competitive” salaries will likely go up, and health and retirement benefits will jump to a new level.
7. Market volatility usually hits public companies first. Private companies can often fly under the radar in turbulent times such as the recent recession. Public stockholders are more easily swayed by emotion and the activities of the crowd, rather than real market conditions, and all performance numbers are public. Shareholders can jump ship quickly.
Before you forge ahead to an IPO, I recommend a thorough readiness assessment to quantify the need as well as to identify potential gaps within processes, areas needing internal controls, and positions requiring enhanced technical accounting skills to operate as a publicly-traded company.
The costs of an aborted IPO are sizable, and may not be deferred to a later period or offering. Along with the time and effort required, this can severely cripple your company for an extended period, not to mention your entrepreneur lifestyle.
While the wins can be big, I still see the IPO option as one to be considered only under exceptional circumstances, rather than as the default exit option. Your odds of hitting the lottery may be better.