Stay Private or Go IPO?
This article by Louis Lehot originally appeared on FOLEY on August 16, 2024: Stay Private or Go IPO?
Public investors have become more discerning about Initial Public Offerings (IPOs). Instead of chasing speculative high-growth stories, they are leaning towards companies that showcase established profitability and sustainable growth. This shift is driven by ongoing economic concerns and market volatility, leading investors to seek safer, more predictable assets. Historically, the demand for IPOs surges when they offer substantial returns. According to the Renaissance Capital performance index, as of June 30, 2024, IPO investors have made a modest 7.41% return on their capital so far in 2024, compared to a 15.29% return for S&P 500 investors. This disparity indicates why many investors are not flocking to IPOs, especially when U.S. Treasuries offer analogous returns with lower risk.
The Private vs. Public Debate for Tech Startups
For many tech startups, the preference is clear: stay private. Successful startups with over $100 million in revenue, growing at more than 30% annually with 40% gross margins, have ample access to private capital. Venture capital firms, private equity, and crossover firms are eager to fund these high-potential companies. The private market offers numerous advantages, such as the ability to sell personal shares in secondary markets, complete exits via strategic buyers, and more control over business decisions without the pressure of quarterly earnings reports.
However, some CEOs are driven by a larger vision that necessitates an IPO. These transformational leaders aim to achieve global market ubiquity, turning their companies into household names, which often requires the scale and capital provided by going public.
Evolving Requirements for IPOs
Since the last IPO boom in 2021, the regulatory landscape has tightened significantly. The current administration has imposed stricter disclosure and transparency requirements, especially concerning environmental, social, and governance (ESG) metrics. The SEC has also enforced more rigorous accounting standards, making the IPO process more challenging and expensive. This environment demands experienced leadership in the C-suite and on the board to navigate these complexities.
Key Hires for a Successful IPO
Preparing for an IPO requires strengthening the company’s leadership with public market experience. Essential roles include:
- Chief Financial Officer (CFO): A CFO with public company experience is crucial for financial reporting and investor relations. The finance department needs robust internal controls, accurate forecasting, and strategic financial planning.
- General Counsel: An experienced general counsel is vital for managing legal compliance and navigating regulatory scrutiny. Larger companies might also need a deputy general counsel focused on securities law.
- Investor Relations Officer: About a year before the IPO, hiring a VP of investor relations can ensure effective communication with analysts and investors, fostering strong market support.
- Audit Committee Chair: An experienced audit committee chair, usually a former CFO, is essential for overseeing financial integrity and regulatory compliance.
Preparing for the IPO Process
Companies must undergo significant changes to be IPO-ready:
- Financial Reporting: Enhanced transparency and accuracy in financial statements, with a clear growth trajectory for the past and future eight quarters.
- Corporate Governance: Recruiting an experienced, independent board of directors to guide the company through the IPO and beyond.
- Operational Scalability: Implementing systems to support growth and compliance, such as enterprise resource planning (ERP) and customer relationship management (CRM) systems.
- Compliance and Risk Management: Establishing robust controls and a compliance function to meet regulatory standards and manage risks effectively.
Investor Expectations and IPO Challenges
Today’s investors prioritize profitability or a clear path to it, sustainable revenue growth, robust key performance indicators (KPIs), and conservative valuations. These criteria differ from previous IPO booms, where rapid growth often overshadowed profitability.
Common reasons for IPO failures include adverse market conditions, valuation discrepancies between private and public markets, regulatory hurdles, and internal operational or governance issues.
Recent Successful IPOs
Some notable IPOs in the past six months include:
- Astera Labs Inc. (ALAB): With a valuation of $5.5 billion, Astera Labs’ focus on AI and cloud infrastructure attracted strong investor interest. Its IPO performance and robust analyst support underscore its success.
- Reddit Inc. (RDDT): Despite initial challenges, Reddit’s large user base, revenue growth, and potential in AI have made it a noteworthy IPO candidate.
- Arm Holdings PLC (ARM): Valued at $54.5 billion, Arm Holdings’ leadership in AI-powered chip design, strategic partnerships, and strong financial performance contributed to its successful IPO.
Selecting the Right Investors
During the IPO roadshow, companies aim to attract long-term institutional investors who will support the company’s growth. These investors typically seek to hold significant post-IPO shares and provide stability in the secondary market. Companies avoid hedge funds and short-term investors who might create downward pressure on the stock.
Alternative Public Offerings
While direct listings and SPAC mergers have waned in popularity, they remain viable for certain tech startups. Direct listings suit companies with strong brand recognition and liquidity, while SPACs offer a quicker route to public markets but have faced increased scrutiny and a spectacular fall in after-market pricing.
Post-IPO Success Strategies
To retain top investors, companies must maintain transparent communication, deliver consistent results, and engage effectively with the investor community. Monitoring economic conditions, regulatory changes, and market sentiment is also crucial for navigating the post-IPO landscape.
These insights provide a comprehensive view of the current IPO environment and strategic considerations for companies contemplating going public.