IPOs and the tech venture cycle

By September 8, 2011Exits

At the end of August I noted with surprise that three midsize tech companies had filed to go public in the US, and said that there success in making the next step to actually listing would tell us a lot about the state of the market.  In the last couple of days we have heard that Groupon, the tech company everyone loves to hate has cancelled its roadshow and is reassessing its plans to IPO, and Zynga is also facing delays (although not as severe), and this comes on top of news that more IPOs were pulled in August than in any month for ten years.

Entrepreneurs and their investors make money when companies are acquired or when they IPO, with the bigger checks usually coming from IPOs.  The upshot of this is that a healthy IPO market has been the most important driver of returns to VC funds, which has a direct knock on effect on the amount of money available to invest in startups and startup valuations. 

Given the centrality of IPOs to the startup ecosystem there are two conclusions to be made from the chart below a) the low level of IPO activity since 2001 compared with the prior five years goes a long way to explaining why the last ten years have been difficult, and b) it is easy to understand why the pick up in the last quarter got everyone so excited.


The startup ecosystem has responded to the dearth of IPOs in two ways, with more M&A, and by developing markets for shares in companies while they were still private.  These secondary markets have a number of flavours – market places like SecondMarket, investments from hedge fund type vehicles like DST, and placements  by investment banks, but all of these markets are underpinned by the assumption that the companies would eventually achieve a traditional exit, with many of the companies trading at valuations which are only likely to be topped by a big IPO.  Hence, whilst the IPO might have become slightly less important in the short term it is still central to the efficient working of the system.

If and when Facebook goes public, and how it fares if it does, will be a very important driver of sentiment and could even set the tone for the whole startup and venture ecosystems for a good couple of quarters.

The underlying drivers of innovation and startup activity remain as strong as ever, but we are all heavily impacted by the overall macro picture and need to bear that in mind as we strategise on how to build our companies and funds.

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  • Hi there Nic

    I have to comment on this as it’s very apt for us as we ourselves are preparing for an IPO.

    A few things to bear in mind here first:

    1) Groupon’s delay in IPO is not entirely a decision they are in control of! Creative accounting may be fine in VC wonderland but it doesn’t wash with the SEC who vets and approves of prospective IPOs. Attempting to conceal your costs of customer acquisitions as an asset and not a revenue expenditure won’t pass muster with the SEC. And then to top it off you have an idiot CEO who in a “close” period decides to vent his frustration with the SEC and rant about the intimate details of their case to all his employees. Groupon has no other choice but to delay because a) it is not in their gift to proceed anyway without SEC approval b) they now need to think about how they are going to present/revise their numbers on the road show & c) explain how their CEO is in fact capable of leading a listed company given his ignorance and disregard of what a close period means. Of course it’s much more convenient to say market conditions are the reason for the delay.

    2) Admittedly August was not an ideal time to IPO given the market conditions. It’s unlikely that September or October will be much better. But market conditions tend to be more critical when it is a large IPO exit. For mid-cap exits like these it applies less (not that it doesn’t apply- but considerably less than for larger cap IPOs). Ironically though, it is often the case that when the market is quiet the companies that do list can often get a disproportionate amount of coverage and interest in the absence of much competition (money makers need to put their money somewhere!), this particularly aids smaller cap IPOs (take a look at Spectra Systems Corp a recent US company IPO on AIM). The “quiet” period also didn’t too much harm to Vallares either!

    3) I make no secret of the fact that I believe VCs have an unhealthy stranglehold on tech IPOs. Not that I’m anti-VC in any way, rather that when a tech companies’ timing (or even the decision) to IPO is driven by the needs of the VC rather than the best interests of the company it does our industry no good at all. There’s a reason why we call these IPOs “Exits”. All too often we see the timing of these IPOs orchestrated so that the VCs can exit at maximum valuation.

    4) The institutional investors and LPs are also getting rather p****d off with the VCs for launching IPOs after the companies have reached the top end of their growth cycle. They’re increasingly wanting to get in on the deals earlier. We know this because this is what they are saying to us. Tech IPOs have increasingly become “Exits” rather than capital expansion offerings and as such, their need for precision timing for optimum market conditions are more acute than other IPOs where VCs are not dictating the timing.

    For all these reasons we’re utilising the platform of an IPO to “launch” ourselves onto the market rather than as an “exit” for our investors. OK, it will by no means be a Google or a Facebook IPO, but it will provide us with the liquidity in our equity which we’ll need in order to grow and at a timing that is driven by the company and not the VC (it’s an LSE listing rather than US).

    As you rightly point out though, in the absence of IPOs for their portfolio companies VCs are left with M&A and the secondary market. Not surprisingly M&A deals seem to be flavour of the month (year) for VCs.

  • Hi David,

    First off, and most importantly, good luck with your IPO!

    Most of what you say is spot on, and it will be interesting to see whether Groupon is able to regain some credibility. They clearly have some issues to work through, but there are a lot of smart people around that business and I suspect their model can’t be as stupid as it sometimes seems. You never know though 🙂