The New York Times recently published an overview of bold initiatives for Silicon Valley to bypass the traditional initial public offering. One idea was to create publicly traded shell companies for buying unicorns. Another was a new stock exchange that favors investors focused on long-term growth. The underlying premise that the public markets are flawed was taken as a given:
It is no secret that the public stock markets… are fundamentally broken. No chief executive wants to live in the glare of the public spotlight and deal with pesky investors who hold stocks in time frames of days and months, not years and decades.
This statement alone is breathtaking. CEOs love to complain about public-company investors and venture investors alike, but none of us would characterize the people funding our companies as “pesky,” even the ones who sell our stock when we fail to perform.
Redfin went public a few months ago, which taught me plenty about the public markets. What I learned is that you get the investors you deserve. You can run the process to take the last penny off the table, and get investors focused on immediate results. Or you can acknowledge the problems with your business, and recruit investors who understand your mission and have the patience to let you pursue it.
We undoubtedly have many ups and downs ahead, so we don’t pretend it will be a cake-walk. It certainly wasn’t when we were private. But the whole idea that we need to give technology companies a break when selling their stock to the public ignores just how much Silicon Valley has already reinvented the IPO process to give itself every possible break.
Tech Companies Already Give Ourselves a Pretty Sweet Deal
This flexibility begins with dual-class voting structures that limit the influence investors have over a company, a practice popularized by Facebook and Google, but taken to new extremes by Snapchat, which sold shares in its IPO that had no voting rights whatsoever. But it also includes classified boards who only come up for re-election on a staggered schedule, so that the board can’t be replaced en masse: 77% of recent IPOs have classified boards, compared to only 11% of the S&P 500.
Perhaps the issue investors should care most about is the ability to limit the number of shares issued by the company for its own benefit. At the time of an IPO, it is now standard to set aside an extremely generous pool of stock for the board to pay employees without future investors’ consent. The result is a company with the latitude to compete for talent, but where the company’s new owners don’t get as much say-so in how the company is run or how much employees are paid.
Who are we to say this is a bad idea? Wall Street’s concerns that such arrangements leave a company with fewer checks against mismanagement were largely dismissed a year ago, and often for good reason: Facebook and Amazon are run better because the CEO can buy companies or invest in new businesses without worrying much about Wall Street’s reaction. Other high-flying companies have not had such great leaders, and the board was lucky to be able to replace the CEO. The point isn’t that limiting investor rights is wrong, only that such limits are possible, and widely practiced among technology companies.
Don’t Pity the Companies Going Public
The real reason there are fewer IPOs has nothing to do with the IPO process itself, which the story described as “brain-damaging;” for most CEOs, going public involves being courted by bankers, flying around in a private jet, and ringing the stock market’s opening bell. Few CEOs seem to be complaining about that. The issue is that many unicorns in the past couple of years have been overvalued by a small number of investors, many of whom encouraged the companies to grow without regard for profits.
Some investors were sovereign wealth funds eager to buy stock in a hot company at almost any price. Some investors structured the deals to pay a high price per share but with redemption rights or other terms that made the price moot, except in a newspaper headline. Many of those investors are already arranging private sales to one-off buyers at even higher prices. And now that the unicorns are asking Wall Street to top those prices, Wall Street is telling the unicorns to generate profits first.
Here Come the Profits
The good news is that most unicorns in fact have been responding by making money, often lots of it, which will over the next twelve months lead to a bumper crop of IPOs. This is an example of the system working, where Wall Street investors encouraged a financial discipline that was less important to companies when we were backed by venture capitalists. The folks in the Valley who want another way out, where we can get more money without making any projections about profits and without having to explain our company in detail to a retiree buying our stock, can just remain private.
A Prospectus Is Not a “Bogus Narrative”
The criticisms of going public don’t move me much. For example, the argument from Chamath Palpihapitiya that the IPO process involves crafting “a bogus narrative” is ridiculous. A cynic could say that about almost any marketing campaign, but not about the marketing in an IPO prospectus, which includes audited financial statements and discloses risk factors, with every claim validated by a team of lawyers. It’s the integrity of this process that many unicorns want to avoid. It’s the part of the process that I found, when Redfin was going through its IPO, almost awe inspiring.
Guidance is For Companies That Want to Be Valued on Future Earnings
I had similar issues with other proposals, like Eric Ries’s idea of a moratorium on guidance. Already, publicly traded companies do not have to guide investors on future earnings. In fact, one company that recently went through an IPO, Etsy, decided against providing earnings guidance. Naturally, Wall Street responded by valuing Etsy on its current profits, rather than its projected profits; since Etsy had up to that point been valued on its tremendous capacity to make money in the future, its stock stumbled. Soon thereafter, Etsy decided to guide investors on its earnings.
This is why the company where I work, Redfin, has also guided analysts and investors on our future earnings. If we made a lot of money now, perhaps we wouldn’t have to talk about the future so much.
There are Fewer IPOs Because, After 20 Years, the Internet is Maturing
The larger issue for Etsy and for more recent IPOs like Blue Apron and Snapchat, is that the prospects of many new Internet companies have dimmed. Blue Apron has to compete with Amazon. Snap has to compete with Facebook.
Unlike the dot-com boom of the ’90s, investments in new Internet companies are hit or miss because the Internet has matured, and the advantages of incumbency are now enormous. As a result, there are more acquisitions of IPO-bound Internet-companies and fewer that can thrive over the long haul on their own. This is why the best possible invention to spur a new set of publicly traded companies won’t be a new way to go public, but a new kind of technology company, a company that can one day beat Amazon, Google or Facebook. Maybe this won’t happen in every market, for every type of customer, right away, but it will happen in pieces over time. Shouldn’t that be what Silicon Valley is focused on?