Notwithstanding the fact that the last several weeks did not go as planned for a few of the companies pricing or looking to price IPOs, and the associated speculation that the IPO window may be narrowing (if not closing) for tech and biotech companies, the IPO climate has recently been strong and sustained. While market conditions are crucial to the timing of any public offering, entrepreneurs and executives should also consider internal company factors when thinking about the right time to take their companies public.
Here are a few points to consider:
(1) Going public and capital raising as a public company are expensive. IPOs and subsequent public offerings come at a substantial cost, which should be factored into the analysis of the cost of the capital to be raised in the process. Even at attractive valuations, the underwriting, legal, accounting, and other transaction costs of an IPO or subsequent public offering often put a company in a position where the capital raised in such a transaction could have been raised less expensively from private investors investing in a private company.
(2) Being public is expensive. Once an IPO is complete, the annual cost of being a public company is substantial. Beyond the fees paid to outside counsel and auditors, a public company needs a robust internal team to manage legal compliance, accounting, and investor relations. Although the JOBS Act aimed to reduce the compliance and reporting burdens that “emerging growth companies” face, the costs associated with operating as a public company nevertheless substantially exceed those of operating as a private company. While these costs are justified once a company can only meet its ongoing capital requirements by having access to the public markets, when (i) additional capital requirements are not high or (ii) such capital could be raised on more attractive terms if the company were private (see point #1 above), the costs of being public may not be warranted.
(3) Going public and being public are distracting. The IPO process is all-consuming for management and comes with 6-9+ months of pre-launch planning. Even once a company is public, management’s attention is constantly diverted by the logistical and practical realities of compliance and investor relations. For a company with a seasoned management team that has experience working together, these diversions are manageable, but it is important to ensure that going public won’t negatively impact the ongoing operation of the business.
(4) The public markets are unforgiving. Earlier-stage companies often need to pivot, both in terms of their business strategies and their management teams. While these pivots are necessary to build a successful company in the long-run, they are often at odds with the Street’s focus on short-term returns and the need to consistently meet or exceed analyst guidance. Although the JOBS Act affords “emerging growth companies” with confidentiality in the early stages of registration, once a company is public, every new strategy comes with an immediate hit to EPS and every management transition is a matter of public consummation. In private companies, these bumps can often be smoother and better controlled.
(5) Sideways quickly becomes downhill for public companies. While institutional investors and analysts may have some degree of patience with a newly-public company, the grace period is short. If investors and analysts lose confidence in a company (see point #4 above), prices fall quickly and coverage and liquidity dry up. This, in turn, makes it more difficult to raise additional capital and change strategies, which can result in an accelerating downward spiral.
(6) The public markets are not as liquid as insiders would like. Even if a public company has an active and liquid trading market for its stock, significant pre-IPO shareholders and management often face challenges in achieving liquidity with respect to the their own holdings as a result of lock-ups, blackout periods, and the sensitivity of the markets to insider sales generally. All of these challenges are exacerbated to the extent that a company’s trading market is less active and liquid, and should be considered relative to an M&A exit that provides immediate and almost complete liquidity (subject only to escrows, holdbacks, etc.).
IPOs make eminent sense for certain companies at certain stages of development, but both market and internal company factors should be considered when determining the best time to take a company public.