I laughed and rolled my eyes when I looked at the sentence above, a search term from Google that brought a reader to a post of mine referencing Zynga’s IPO. No offense to the innocent internet wanderer who stumbled upon my site through that horribly constructed sentence, but he/she highlights a problem with the IPO exits of many of these buzzworthy tech companies. I’ll discuss them in the popular lazy blogger format of “some bolded words as a means of generating structure”:
Everybody involved in the startup wants the company to exit, eventually.
Most people involved in young companies like being involved in young companies. Typically the talent at young companies got there in one of two ways – they always worked at young companies, or they left big companies to work with young companies. Both of those sorts of people end up wanting to work at young companies, which means that if the young company works out and becomes a tremendous hit, the company is no longer the sort that the person wants to work for. It’s ironic (I think, though after being peeved by other people when they incorrectly label something ironic for so long, I’m actually beginning to wonder if the word has any meaning whatsoever). Look at the co-founders of a startup you pay attention to, and it’s almost guaranteed that they jumped over to startups from a larger company in the space, or they’ve always been a startup person. Startups draw a sort of entrepreneurial spirit, which typically isn’t sated by the bureaucracy of an IPO-ready company.
Despite my personal turmoil over the uses of the word ‘ironic’, it is decidedly not ironic that venture capitalists want the companies they invest in to exit. VCs have two goals: invest money and make money on that investment. It’s hard to make money if the company never sells to anybody and never IPOs – the company must make an exit in 90% of circumstances, or the VCs delay reporting a success to their limited partners. Only with rare, super successful mega companies can a VC potentially get out of an investment with a gain, but that’s not ideal, as it forces the VCs to rely on inaccurate, non-free market pricing and the wiles of the secondary market for private stock, a market that probably shouldn’t exist and requires approval from the company for the institutional investor to access.
And we are now seeing a third group that clamors for an exit, though only through an IPO – the everyday investor. Mr. “when does zynga shares hit teh market” wants in on the big private companies he reads about, and wall street wants to get in on the action as well. Private companies can legally only be held by 500 people before the company must report to the SEC as if it were public, essentially forcing the company to go public when it reaches a certain capacity. If you aren’t in that lucky 500, Zynga, Facebook, and Groupon stock has been off-limits (largely, and in the US) despite the fact that half of the tech articles you read are about the three companies. So everything is lined up from the beginning to push startups towards an IPO exit, or a sale to another company.
Everybody involved in the success of the company is probably leaving when the company exits (aka when Ivonna Zyngastock buys her shares).
People get terrified at the slightest hint of news that Steve Jobs is ill. When Jobs coughs, Apple stock drops. Not that every founder is as valuable to their company as Jobs is to Apple, but there is a general consensus that the founders are pretty darn important, even when the company has years of institutional knowledge and thousands of employees. You could argue that the founder is even more important to a small company with less institutional knowledge and likely a smaller number of employees. Obviously not every founder leaves the company when the company exits, and often in acquisitions the key founders are contractually obligated or heavily incentivized to stay, but many upper level executives feel compelled to leave. For one, the desire to work with startups outlined above makes founders want to move on to their next venture. Upper level execs are also likely to be holding on to years worth of stock, and looking for a chance to finally make some money for those shares they’ve had for so long, and often divesting from the company financially means divesting personally. Employees at all levels can now also jump ship more easily, as the pressure to stay to make something off the stock is no longer there.
Success is also, in part, driven by the investors (at least, if you believe the investors). VCs have tangible connections and expertise in areas, often with insider knowledge of the going-ons at other companies they invest in. But once the company exits, the VCs are less likely to play an intimate role in the company’s direction and business decisions. VCs at least see their % ownership of the company decrease, especially as they begin pulling their own stock out to make money on their investment (which has, like the founders stock, been practically illiquid for years). Another odd part about this is, the VCs are the ones who set the price of the company closest to the IPO – take Pandora for example, which just had an IPO despite the fact that the company doesn’t make any profit. Or Groupon, who raised nearly a billion dollars from VCs, then paid most of it out to other investors, then reported a loss for the quarter before their IPO. How do you value a company with no profits? VCs set valuations in the most recent series round, and often the IPO price is, at least in part, based on that valuation. So VCs sort of cooperate to create the illusion that a company has an enormous amount of value, then they dump the company on the public and sell those shares to investors who’ve only heard about the company because of the reporting generated by the investments the VCs made in the first place. I’m not saying it’s crooked or anything – probably just basic marketing – but when the public hears about how valuable a company with no profits is, and then the guy who last invested is very excited to sell, some alarms should go off.
Public disappointment in the quality of companies in the IPO market is what drives the tech bubble cycles.
So all of the above is driving cycles where the public hears about awesome companies, but then gets to invest at a point in time where the company is probably undergoing its biggest transition in terms of culture, turnover, and makeup at the top. Sometimes it works out or the founders truly retain control (google), but often it doesn’t, and if the hype gets too big around a few success stories, its in the best interest of the founders, the VCs, and everybody “in” the bubble to keep pushing young companies to IPO, then jumping out to show a strong short-term gain on the financials or cash out the founders cheaply-bought stock. Eventually the public catches on, gets frustrated buying shares of hot young companies that aren’t businesses yet but are still valued in the millions, and the public stops buying. The fact that people who can’t even construct sentences are googling to find out when they can buy into Zynga is great in some ways – if the overall value of the companies coming out of sillicon valley is high, then the companies deserve the buzz and the valuations – but in other ways it’s bad – once the public starts getting carried away with IPOs, the next phase is discontent with the performance of the companies, followed by a quick burst of the bubble. So get your Groupon stock while you can, but remember that all the people who’ve believed in the company up til now will probably be doing the opposite. (Note: Zynga is great though, I’ll probably be a Zynga stockholder one day. Anybody who can make millions selling 50 x 50 pixel art is on to something.)
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