It has been at least a decade since going public via an Initial Public Offering (IPO) has been considered a credible exit strategy for startups. But the word is out on Reuters that LinkedIn, Twitter, and maybe even Facebook are looking hard at going public this year, so all of a sudden the IPO option is back in business plans again as an exit strategy for startups.
But before you jump on the bandwagon, you should consider the advice I saw recently from the maven of venture capital, William H. Draper III, in his new book titled “The Startup Game.” He says that you should never consider a public offering unless you are confident that the company will deliver increasing profits and revenue after the offering, so that the public buyer can anticipate a gain.
According to Draper, in addition to the above Rule Number One, there are many other questions that need to be answered before a CEO should recommend to the board that it is time for an IPO:
- Do you really need the money? If the company is growing like crazy and has only a modest income stream, the answer is probably yes. If the company is just bumping along in a quiet niche, with no bright prospects in sight, the answer is probably no. Being thinly capitalized doesn’t necessarily mean you need a big cash infusion.
- Is the money going to be enough? Usually a small company can sell about 20 percent of its stock in an IPO. Run some scenarios, including some very conservative ones, and see what going public is likely to yield. If it’s not enough, don’t do it.
- How’s the timing? The timing of an IPO is driven heavily by the state of the economy in general and the stock market in particular, in concert with your profitability. The market is moving back up, but slowly. In 1999, there were 486 IPOs nationwide; just 10 years later, in 2009, there were only 63. Is your spotlight bright enough to start a new wave?
- Do you need the IPO for your acquisitions strategy? Sometimes the best way to grow is to acquire other companies or other products, and sometimes you need a public stock in order to go that route. Of course, you’re going to have to perform well to make that stock useful in the acquisitions process.
- Do you need this for recruitment and retention? Liquidity can help attract new employees and keep current ones happy. If you have been giving stock options, employees will want you to be a public company, to exercise their rights to buy the stock and sell it at a profit.
- Do you need this for your image? Rightly or wrongly, public ownership often lends prestige and credibility to the company in its sales efforts, general public relations, and the execution of its future strategies.
- Do you have the horses? Are you ready to answer to the new public stockholders and accept responsibility for both the good and the bad as it unfolds in an uncertain future? Do you have the CFO, and the best legal and accounting help to comply with the audit requirements of the Sarbanes-Oxley Act? These can add millions to the cost of doing business.
Then there is the formidable process of taking the company public. It will take at least three months, and require endless amounts of time, money, and energy. You need to work through a team of underwriters, who administer the public issuance and distribution of securities from a corporation. False starts in this direction can be disastrous.
At any rate, it seems only appropriate that social media sites, which have dominated the Internet over the past few years, will likely lead startups back into the IPO game. Like other startups, they no doubt have private investors eager to cash out, and it certainly appears that the big three social networking firms could be well-regarded for going public. Which stock would you bet on as the leader?