Where Are All the Tech IPOs in 2011? Part Two.
In my last post we examined the IPO history in Silicon Valley and wondered why we have not seen more IPO activity this year. There are some big, well known consumer internet companies poised for IPOs with ostensibly favorable market conditions, but none have gone out. How come? My take is there are three key several reasons:
1. Institutional buyers are very cautious, and their liquidity might still be an issue.
2. These are still young companies and need more time to cement their business and financial models and don’t need the distraction.
3. They don’t really need to go public.
1. Cautious institutional buyers
This may be the biggest factor preventing more tech IPOs from going out. Despite the improved market, institutional buyers are wary of making the same mistakes they made over a decade ago when dozens of unproven, high risk internet companies went public priced at untenable multiples, only to later evaporate with the NASDAQ meltdown.
It is possible they are demanding more proof of predictability and sustainability even from the big names before they participate and that’s not bad thing. Companies like Twitter and Pandora, in the news every day, have not proven their model sufficiently to raise money through the IPO process. Yet, underwriters and probably many investors may be willing to take a chance with an IPO from these companies because of the “coolness” of their services. But will they be able to develop a sustainable business model? One hopes so.
Larger companies like Facebook, the 800 pound gorilla that everyone is waiting for to set a trend, has a much different issue. Based on its shares trading through private transactions, the company is valued at ~$80 billion. Let’s assume that Facebook sells 15% of their company in an IPO. That means the investors have to have liquidity in the range of $1.2 billion at one time. And if the investors do have that much liquidity, what will Facebook do with that much cash? Then add in the IPO for LinkedIn, Pandora, Twitter, Groupon and Zinga, which combined might account for another $10 billion, and the problem of liquidity for institutional investors becomes even larger. Where will this money come from?
One solution might be for some of these companies to consider remaining private, and continuing with the private transactions for their securities until they reach a number of shareholders (currently 500) which requires them to become an SEC registrant under the ’33 Act. Then, their shares will effectively become “registered” and there would be a more liquid market for trading in these companies.
2. Still young
Just as in #1 above, many of these companies, though well known and widely used, may not have established enough of a predictable history of profitability to permit a successful IPO. For some like Pandora and Twitter they have not reached sustained profitability or positive cash flow yet, and their business model does not seem to answer the question of when and how. So fortunately their management and investors, with probably some urging of institutional buyers, are opting to focus on making their companies more IPO-ready. And despite their billion dollar market values these are still young, evolving companies in rapidly changing markets. We applaud that decision, a tough one given the temptations of having a hot company. Similarly spending millions on preparing for an IPO and then managing a public company would be huge non-positive distractions and drains for management and boards.
3. They don’t need the money
Historically the # 1 reason companies went public was their ability to raise ample private capital at healthy valuations. However, in the case of many of these successful internet companies, raising additional capital is not the primary driver. These companies have been able to raise significant institutional money at healthy valuations. With huge valuations, these companies would need to sell many billions of dollars of stock just to get enough float to support a public market, which is more capital that they need for the foreseeable future. In addition the emergence of secondary markets and exchanges for private company stock has relieved the investors, officer and employee liquidity pressures that are often serve as an additional driver to an IPO.
So in summary, with the costs of going and being public so high and the need for capital and liquidity diminished, these big names are focusing their attention on their core business, intent on further refining and solidifying their growth path, profit model, and predictability. As such if and when they go public, they’ll be that much more attractive an investment for institutional and individual shareholders alike. It just may not be in 2011.
Rich Brenner is Founder and CEO of The Brenner Group, one of Silicon Valley’s premier professional services firms. Rich is a veteran executive, entrepreneur, investor, board member, and philanthropist.
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