In Defense of Being a Public Company
7/7/2015
We are in the middle of the greatest revolution since the start of our species - the Information Revolution will dwarf the Cognitive, Agricultural, Industrial, and Technological Revolutions of the last 100,000 years. Billions of people around the world are connecting to the Internet, climbing out of poverty, and overcoming difficult political regimes. As the world changes, every company, no matter where they operate or what industry they are in must become a tech company. This is creating an enormous opportunity for entrepreneurs. At the same time many legacy companies are losing relevance, leaving the public markets starved for high quality investment opportunities in the technology sector.
This is a fantastic time to become a public company, yet a growing fear of IPOs and public markets has developed in recent years in Silicon Valley. There appears to be bravado in staying private longer, which in my opinion is a risky and misinformed posture. In the extreme examples, entrepreneurs have been frightened into believing public market investors are exclusively short term focused, math-ignorant, monsters that intentionally misunderstand startup businesses, and short them into bankruptcy. This is at best misinformed. At worst, this view greatly increases the risk of a company’s survival. Many private companies today would thrive with access to the liquidity and capital available public markets.
The fear of being public seems to find its roots with venture capitalists that may have had prior bad experiences with the public markets. Ironically, these same VCs are typically proponents of free markets – both the stock market and the marketplace of ideas – but in this case seem scared to allow their companies a birth into the fully audited and debated process whereby supply and demand meet to determine a reasonable approximation of the present value of discounted future cash flows. Public market investors do not short businesses with solid long term prospects into non-existence. A marketplace of opposing viewpoints coming together to determine a company’s value is lower risk over the long term than a handful of folks, that might tend to think alike, arriving at a number in a private fundraising.
I concede many public market investors are short term focused. But, there is an enormous asset pool, dwarfing even the venture capital market, which is indeed long term focused. These investors are capable of analyzing the so-called “new” business models of subscription software. Contrary to popular beliefs among private companies and venture capitalists, Silicon Valley did not invent subscription businesses. Wall Street has been analyzing subscription businesses with upfront acquisition costs and churn for a very long time - Cable and Telecom companies, to name just two examples. The math of a SAAS or a consumer Internet company is not a mystery to any investor on Wall Street. VCs have no edge over public investors in their ability to value a late stage tech company, even when big picture, long term thinking is required while profit losses are incurred in the short term.
Going public has several tangible benefits. It creates a significant branding event for a company which drives leverage on marketing strategies. It shores up balance sheets with a low cost of capital cash infusion and gives companies a currency for acquisitions. A stronger balance sheet and audited financials will garner more customers, helping accelerate growth rates. A public stock allows liquidity for employees and can help in the hiring process if incentives are properly aligned with good long term performance. In short, being public is both good offense and good defense - and, you will be forced to raise your game across all functions of your company which will make you a stronger competitor as you challenge incumbents.
I meet regularly with private companies that have the fundamentals to justify being public today. However, fear and access to currently abundant late stage private financing keeps them private. The late stage VC bubble may continue for a while, but at some point it will stop. And, when it stops it could come with a market environment that is not as favorable to going public. If that happens, the risk of staying private too long will be exposed, and many great companies will face a financing crunch that could put them out of business or force a premature exit. However, as a public company, your stock may temporarily go down, but if you believe in the long term prospects of your model, you will always have access to fundraising or the ability to do M&A. When the late stage VC bubble ends, if you have a great long term model you believe in, you want to be public. Staying private for too long exposes your company and employees to unnecessary risk.
Completing late stage rounds at high valuations when you are hiring at a rapid pace can create another challenging situation. Expectations must go ever higher to the point of absurdity to justify the valuations which have not been publicly vetted. Once public, this creates tension between companies and investors while also opening the door to bad decision making. Often management teams will blame Wall St for forcing them into thinking short term. However, if Wall St is defining a company's strategy, i.e., running the company instead of management, then the management team is letting down their employees and shareholders. Wall St. does not run companies, and it does not set expectations – this is the job of solid, long term focused management teams. Managing a smoother transition between the private and public threshold helps avoid many of these behavioral problems.
There is enormous pent up demand for the next wave of technology companies which should be met eagerly with a wave of IPOs from the brilliant founders - what are you waiting for? Show us what you got!