What does the current IPO market look like to public
investors?
As of today the answer is
high risk and not so high reward.
Put yourself in the shoes of the institutional investor. Most
of my investor friends love the thrill of a new company in their portfolio, but
the unfortunate truth is that while the IPO is very important to the company
going public, it contributes very little to the average institutional
investor’s performance. To understand why you simply have to do the math. The T
Rowe Price New Horizons Fund has $ 14 billion under management. Even a generous
top 10 IPO allocation on a $ 100 mln IPO would hardly move the needle at less
than 1/20 of 1% of that portfolio of stocks. Since Institutional investors are
marked to market publicly every day, when markets are uncertain and stocks
volatile, they logically focus on the bigger existing stocks in their portfolio
that move the needle on a daily basis. Time leftover for IPOs becomes very small.
Another cloud hovering over the IPO investors’ heads today
is the poor performance of those brave few IPOs that have ventured out in
recent month. Investors have felt the
pain as 55% of IPOs since August are trading below issue with the average return
of just 2.9% from IPO. The good news is
that those returns are slightly better than the return on the S&P over the
same time period, but large institutional investors buy a majority of their
shares in the aftermarket where returns have been a negative 5%. Even bell
weather IPOs such as Ferrari and Pure Storage have broken issue. When a deal
heads south, the liquidity for that newly listed company dries up quickly. Many a fund manager has been caught with IPO positions
trading below issue, a situation that may attract the scorn of investors and the
consultants that recommend their funds.
While there are a few promising signs including the major
indices moving back into positive territory for the year and the VIX (Wall
Street’s proxy for fear and uncertainty) coming back to earth after
skyrocketing in late August, the IPO market may be schizophrenic for some time
to come.
Challenging market not withstanding, as the calendar year
changes, we may see more companies heeding the advice offered by salesforce CEO
Mark Benioff at a recent Fortune Global Conference:
"Public markets
are great for CEOs. You have to answer to the public market. You have to listen.
You have to pay attention….. Entrepreneurs are making a huge mistake in waiting
too long to go public"
What lies ahead?
Some smart companies will forge ahead although they may face
a discriminating and more crowded market given the number of potential IPOs
delaying in Q4. Those that want to maximize odds of potential success should
take a few key steps.
1) Have a compelling reason.
When markets are tough investors will want to know why a
company is moving ahead rather than waiting for calmer seas. Is it hubris, desperation or something more
rational?
“Why do you want to be
a public company and why now?” will very likely be the first questions in your
roadshow meetings. Be very sure you are
clear on the answers to both and be equally sure that you can clearly
articulate the answers. Just a
suggestion but “Our burn rate is really high and our early investors want out”
is not likely to resonate well with public investors.
Conversely, if you
can explain how an investment today should accelerate the growth of your
business, give you a marketplace advantage and presumably lead to stronger
returns tomorrow, you will likely keep investors’ attention, at least long
enough to hear the rest of your story.
2) Demonstrate a credible roadmap to profitability.
Surprise! Profitability matters after all. Expect public investors to be focused on your
path to profitability. When markets are sailing along smoothly and funds are
attracting new investment dollars (inflows), investors’ minds drift out the
risk curve. In good times, they are willing to pay high multiples on revenue
for growth, daring to dream that the rest will work itself out over time. In
uncertain times when volatility is up, inflows are stagnant or negative and IPO
returns down, investor focus turns to self-preservation and limiting downside
risk. The dare to dream valuation scenario goes poof when markets are falling.
Newly issued, track-record free stocks with valuations built on a dissolvable,
sugary rock candy mountain of imaginary profit and cash flow will be punished
the most.
In these times, while current profitability may be optimal,
it may not be possible without throwing the growth plan into a tailspin. Having
a credible roadmap to profitability over the next 4 to 6 quarters, an
appropriate public investor time horizon, is the next best thing. Combine a path to profits with a compelling, sustainable
growth trajectory and you have meaningfully increased your odds of a successful
IPO. The IPO will look even more appealing if the numbers presented to
investors are on the upswing, meaning past any trough in Ebitda, with bankers’ profit
margin estimates showing consistent and tangible progress towards black ink.
Investors feel more confident when companies talking about levers to
profitability and can actually demonstrate that those levers work.
3) Set conservative expectations.
Investors will want to see that you are conservative in the
public expectations you discuss for the business. One third of companies miss
analysts’ numbers by the second public quarterly report. Be clear about your expectations for the
business and what might be potential drivers of outperformance but be even
clearer about the challenges ahead. Don’t fail to acknowledge future head winds
and under play possible future tail winds. Savvy investors want management to
relay a conservative view of the world and then outperform against it. Bottom
line: set achievable expectations and communicate them clearly.
4) Raise money when you are comfortable, not desperate
If cash on your balance sheet is $13 million and you are
burning $ 15 million this quarter, you can bet investors will go for the
jugular. Institutional investors are master negotiators and if they see
weakness, they will show all the mercy of a great white circling a slow,
blubbery sea lion. To minimize their opportunity to extract more than a fair
discount, time an IPO so that your balance sheet shows comfort not necessity. You
would be well served to compliment that cushion with a credible path to
profitability that can be achieved with
this round of equity financing. Public investors do not want the guarantee of
future dilution or even worse, a subsequent inability to fund in uncertain
markets.
What about those
hush-hush ratchets and triggers? Let's start with the fact that those
potentially costly and dilutive preferences are detailed in The S-1. Make no
mistake, institutional investors read that fine print. Not surprisingly, they
are never excited about paying direct deposits into the pockets of earlier
investors; there is a zero ROI for them on those dollars. Understand that they get the joke and will
factor those dilutive clauses into the price they are willing to pay for the
IPO. Savvy public investors will value
your IPO as if triggered. If it’s a tough market, work with your private
investors to make the problem clauses go away – or at least try. Hey, nothing
ventured….. Those companies that have horse-traded preferences in exchange for
high private company valuations, and those investors that have asked for them,
may need to compromise to get to the mutually beneficial goal of access to the
public capital markets.
Understanding both the big picture and the nuances of the
IPO process can make an enormous difference in the outcome. Need more examples and suggestions? Get in
touch. Class V Group is laser focused on
helping great companies, and the inspiring entrepreneurs who build them, sail smoothly
and successfully into the public markets.
