Rude VC – Going public: It’s complicated (part 2)

May 22, 2012
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{Note: this post represents the second installment in a Rude VC series on IPO. The introductory post is here.}

Last week in this column we reviewed the basics on an initial public offering, particularly the flavor available in France. Unless you’ve been living in a cave, you would know that since then, Facebook has gone public, having raised $16 billion in its initial public offering and begun trading last Friday.

Facebook’s first two days as a public company were anti-climactic, to say the least. On its first day of trading, the stock didn’t pop; it barely budged, opening at $38 and closing at $38.23. Its bankers were even forced to buy shares to prevent a symbolically devastating slide below it’s IPO price. (By the way, I would argue that this outcome was actually a good thing for Facebook, as the company pretty much maximized its IPO fundraising at minimum dilution). But the absence of the customary IPO day run-up combined with yesterday’s significant decline in the stock price certainly deflates a lot of the market euphoria surrounding the IPO event.

Last month Wired magazine featured a great piece assessing the tech industry’s “senseless addiction to the IPO.” The article cites the example of Facebook, which in preparation for its IPO the company instilled a number of safeguards — such as enabling Mark Zuckerberg to retain control of over 55% of the voting rights, to unilaterally appoint directors, and to name his successor — that Zuckerberg will continue to run it like his own privately held concern. So when a company as successful and omnipresent as Facebook tries to minimize the impact of being public, one has to wonder if the IPO model is broken.

Part of the problem in the U.S. is that new regulations like Sarbanes-Oxley have made it extremely costly to be a public company. And since the dotcom collapse, internet companies must demonstrate consistent profitability before going public. So in order to go public, a company must already have a horde of cash.

That leaves the principal rationale for an IPO to be one of providing an exit to shareholders. This is generally a good thing, because the company can use the prospect of going public to lure top talent with equity.

However, this is also where shareholders’ interest diverge. Founders and key employees cannot easily sell their equity shortly after an IPO. First, there’s often a lockup provision for many of them. But even beyond the lockup, a founder selling a significant chunk of equity can send a negative signal to the market and erode confidence.

The VC’s, on the other hand, intend to and are expected to sell their equity stakes post-IPO in an expeditious manner. In fact, the VCs’ obligation is to maximize their investment performance, not the long-term performance of the company. Since the ‘equity story’ of a successful tech IPO often revolves around the theme of high growth, VC’s may push their companies into unsustainably high cycles of growth in effort to accelerate the IPO event and thus optimize their exit.

I submit that on this side of the pond, at least in France, the IPO model isn’t suffering the same problems as in the U.S. But that’s not to say that it’s flawless here either. On the contrary, I would argue that for high-tech startups in France, the drawbacks of going public generally outweigh the benefits. I’ll explain my rationale in detail in the third installment of this series on IPO’s.