Tuesday, May 10, 2016

Perspectives on the IPO from Recently Public Company Founders and Management Teams; It was Tough but Being Public is Well Worth it!

As quiet as it has been, we have no doubt that the IPO market will be back.  As we have said before, we need a company or two with good numbers and brave management to break the ice. SecureWorks [SCWX, NASDAQ]  doesn’t really count as it was a spin-out from a larger entity not an A-round-to-IPO-story. But one of these days, some company on file will convince “oh no, let someone else go first” bankers to hit the road(show), take the plunge and bring back the IPO.  Yes for some, that may be a challenging call as they are likely to have to accept the new catch phrase “An IPO – It’s the new down round”. The sky-high private valuations on more than a few will have to face the cold-hard reality of a discerning public marketplace that is unwilling to "price for perfection" right out of the gate.
But no need to dwell on those tough details here because whether we see the transaction in 2016 or beyond, 100 or so private company management teams recently joined us at the New York Stock Exchange to learn about the markets, what it takes to go public and what steps they might take now to make the process easier “then.”
Leslie moderated a panel of recently public company management teams including Peter Bauer, the Founder, CEO and Chairman of Mimecast, Jennifer Moyer the CFO of Alarm.com and Matt Kaminer the General Counsel of Instructure. The hope was to share the hard-earned wisdom of those who had recently gone through process with those for whom the experience is yet to come.  The overriding message from those who have run the gauntlet to those thinking about it: “It’s tough but well worth it”.
Below, a straightforward summary of the questions and answers from that panel: These are not our thoughts; they are the words of wisdom from the panelists.
What was the single best thing about the IPO process?
The single best thing about an IPO is the pride and morale lift across the entire company. The feeling that we are good enough to be playing in the big league has been a huge confidence builder. I was worried about the stock price being a distraction but internally I spend very little time on that as employees are focused on execution and have taken a long term view.
What factored into your decision to peruse and IPO?
First, the transparency of being a public company is a big advantage when selling to enterprise customers and establishing partnerships. The IPO can be quite a positive event for the company from that perspective. There is a tremendous amount or publicity and awareness that can benefit any company really and we were shown how to optimize the process. So the IPO was the right thing to do for the business at the right time for the company.
Second, investors expect a path to liquidity—if management/founders want to maintain control over the destiny of the company an IPO is the only way that keeps the management team in the driver’s seat. Other alternatives-- Sale you lose control and become part of a bigger animal and a PE deal is similar you cede control as they cut growth investment and bring in their own management. If you believe in the long term potential of your company and IPO is the only viable declaration of independence.
How has the IPO process changed your company?
There is a lot on compliance and legal stuff involved in an IPO but at the core, a large portion of the work makes you a stronger company. We had to focus on separation of duties, process, clear lines of communication and accountability, on accuracy, removing risk, forecasting and planning. The IPO process tightens everything up. It is great to lead a company that has gone through a transition to a public company. We have a more finely honed ability to execute. What used to be best efforts is now and intensely analyzed and high conviction yes or no.
What would you do differently if you had it to do over again?
The one thing I would do differently is the have dual class stock to keep the focus of the company on the long term. The public markets seem to be irrational at times and although we have put all the protections in place like poison pill and staggered boards, dual class stock would provide and extra piece of mind that the focus will remain on long term value creation.
As a CFO the one thing I would do differently is to have an in house investor relations function from right from the IPO day rather than outsourced IR. The biggest surprise to me has been how little public investors actually know about the company and the time and effort involved in educating them. We chose an outsourced solution just for convenience at the time. A focused internal investor’s relations function is something I would have invested in earlier.
What tip would you give the audience on how to prepare?
Spend time with public investors and research analysts well in advance of the IPO to educate them on the company and learn from them is incredibly valuable. That said, make sure your company presentation is public company ready and that management is prepared well for the interaction. Investors will take notes and remember everything you said so pivoting later is difficult and a bad initial impression can lead to a rejection at time of IPO. Make sure you are very well prepared.
Spend time with bankers but not too much time. There is value in getting multiple perspectives; they are super smart. Don’t be blinded by big brands, there were some who didn’t get it or who were too busy to give us attention.
What are the keys to success?
You must set conservative expectations and outperform them. The ability to beat and raise is very important and takes tremendous practice; setting expectations correctly is an art. As a management team we were coached to think of the cadence of quarterly reporting like chapters in a book—it is your story playing out on a quarterly basis and each quarter must show some evidence that your story is working and working well.
Do you need to have been a public company CEO, CFO or GC to take a company public?
A company does not need public company experience to successfully navigate the IPO process. More important is a passion and vision for the business. Public investors like founder led businesses as long as the founder has built a deep bench of surrounding experienced management teammates.  CFOs need good judgment, a deep grasp of the financials and a hopefully, an affinity for talking about the business with investors. The General Counsel needs to know how to build and lead a legal department.  Advisors including IPO experts, experienced legal and accounting firms can provide the expertise needed to get through the IPO process and to launch a successful post IPO public company strategy.
Final advice from one of our founder/speakers: “do not limit the company's potential because of your own doubts about your ability to be a public company CEO. If it is in the best interest of your company it is certainly something you can do".

Tuesday, March 22, 2016

The IPO Market – First Quarter Showers May indeed bring Subsequent Flowers

Until recently, rapidly growing technology start-ups, aspiring to perhaps one day be public, seemed to embrace the old adage: It takes money to make money. When money was readily available to finance growth as long as management could tell a good story, start up after start up scrambled like four-year olds at an Easter egg hunt to gather up as much as they could.  However, they may have been adhering to the wrong proverb.  Perhaps the more appropriate wisdom came from Thomas Jefferson: “Never spend your money before you have earned it”.  We think it highly likely that over the next few quarters, participants in the IPO market will have data to conclude which was better advice.

Just six months ago, spending to grow, even if the positive unit economics and cash flow were on the come requiring a leap (and a bound) of faith, a young company’s management team appeared wise to pursue a competitive moat based on scale, growing as fast as possible. Let the P part of the P&L sort itself out over time.  Damn the torpedoes; go for growth and scale funded by enormous private fund-raising rounds.

Ah, but some of the key “sugar daddies” didn't see the opportunity through quite the same lens.  Public markets did not sing from the same hymn book as their private market brethren.  In 2015, realized IPO valuations did not reflect that same optimism for growing companies in big markets with hefty losses.  Companies that successfully executed an IPO in 2015 often - as in close to 60% of the time according to Renaissance Capital’s 2015 US IPO Review - saw their stocks quickly tumble below issue, and now are living through the painful aftermath with employees, partners, customers and board members. 

If it is true that misery loves company, then there is some solace. According to the same Renaissance Capital analysis, if an investor bought the entire IPO class in 2013 and held through 12/31 of that year, that portfolio would have appreciated 40.8%.  Had they repeated the exercise in 2014, the gain would have been 21%.  Had they followed that tried and true strategy in 2015, those investors would have lost 2%, versus a 0.7% loss for the S&P500 last year. Worse still and again according to Renaissance Capital, had one invested in every VC backed tech IPO in 2014 and 2015, the portfolio would have returned 7% by year-end 2015.  Alas, if one had simply parked money in a NASDAQ index fund, the gain during those two years would have been 20%. No wonder many public investors went to the sidelines and participation in IPOs narrowed dramatically as 2015 progressed.
Fast forward early 2016. As lore has it, March, often a robust IPO month, did indeed come in like a lion.  Unfortunately, it was Cecil. The good news is that while that poor beast is in permanent repose, the 2016 IPO market may yet stretch, stir and awake from the long nap, refreshed, perhaps healthier and ready to go.

Why the optimism in the face of no visible evidence?

First, the VIX is falling.  Volatility is the enemy of the IPO.  When all equity positions look risky, who needs to pile on the incremental challenge of unproven, statistically likely to trip, always unpredictable new issues?  Conversely, when the market chills a bit, and the VIX falls as it has been doing each week since the beginning of February, investors turn their attention from risk avoidance to incremental upside, a mindset favoring IPOs.

Second, public equity is looking increasingly compelling if for no other reason than the private funding environment has grown much more challenging.  Companies relying on unending, generous access to late stage equity to fund further growth are scrambling to come up with a new game plan.  Of course, many raised enormous piles of cash while the getting was good and therefore have a robust bank account. However, history suggests that when money flows freely, emerging companies have a tendency to develop free-wheeling, slow to break habits that eat through bank balances like termites through grandma’s back deck. When private money is hard to come by, public money, even with inherent attached obligations, looks increasingly appealing.

Third, Last year’s “growth, at any cost, is good” mentality has given way to that old bugaboo, insistence on potential profitability. Public investors want to see proof not only of growing ongoing engagement from existing customers, a sign that the offered product or service has convincing value, and therefore a reliable, sustainable, expanding revenue base, but also a tangible demonstration of how that revenue stream will someday yield positive free cash flow.  Companies investing rationally in their product roadmaps and in deepening integration with (and value to) customers, will likely have a much easier time winning the hearts and minds of IPO investors (when they come out from under their desks).

When investors are fearful that private company secular tailwinds will slow, leaving them becalmed in a big market with hungry shark incumbents competing for the same, dwindling school of customers, the upstarts can only prevail if they offer something compelling, proprietary and sustainable.  As of March 2016, our conversations with investors suggest that competitive barriers, an ability to maintain a leadership position even in a long economic slog and a rational view of valuation are now more critical to the investment decision than yesterday’s secular trends, fairies and sugar plum TAMs. The market where “land-grab-today-at-any-cost-and trust-we-can-monetize-this-big-opportunity-later” wins has left the room. Conversely companies that embrace the mindset and work to deepen moats today while keeping spending under control should be well served when public investors’ un-circle their wagons and again seek out new territory.

Our strong sense is that the uncertainty created by a tighter private funding market is leading companies to rapidly embrace the principles that public investors say they want, a more balanced approach towards growth and profitability and a focus on moats and again, justifiable valuation expectations. Our optimism for the new issue market ahead is based on our belief that this revised thinking will result in stronger, more compelling IPO candidates.

So, once the clouds clear and a brave bellwether opens the market, is it all clear skies and sunshine ahead?  Of course not.  Some companies will come to market with models reminiscent of that FarSide cartoon mathematician “And then, a miracle occurs”, and some of those IPOs will fly off the shelves.  What happens to those companies after the lock-up release 180 days later will be anyone’s guess.  Having seen this movie before, we can say that if history is any guide, emerging companies that are hunkered down in the current environment, perhaps foregoing triple digit growth in the drive toward the sustainability afforded by a viable model displaying balanced growth and profitability, are the best bets.

The current IPO forecast is gloomy; no doubt.  However, what is going on beneath the visible cloud cover just may be enough to afford public investors positive returns again in the IPO pool when the sun shines and it is time to dive back in.

Sunday, February 7, 2016

Even the best fumble at times: Tips for handling an earnings miss

It’s been a rather bumpy earnings season.  Companies that made their estimates and offered reasonably positive guidance fared well, at least on a relative basis. Companies that hit their numbers but issued cautious forward-looking statements, were crushed in the marketplace; see LNKD or DATA.  Then there is MTCH, a company that missed top line expectations first quarter out of the gate; that is a little like making a Valentine’s Day reservation at a fine restaurant and failing to show up, leaving your date sitting alone. You've created a memory that definitely isn’t going away any time soon. Like, ever.

There is no way to insulate a stock from market swings. Results that might be benign in one market are miserably malignant in another. However, it is possible to minimize the damage, either in scale or duration and so, in the middle of this “earnings season”, we thought it might be useful to revisit some earnings release strategies.

Note to Recent IPOs: DO NOT MISS. Really. DO NOT MISS

When investors take the risk of investing in a new issue, an IPO, they have certain expectations about the “out of the box” performance of that company. First, investors expect the company to deliver results in-line or better than what the underwriting investment banks’ analysts forecast during the road show. It is no secret that analysts in the underwriting group receive detailed guidance from management and while from time to time an analyst will go rogue, in general the initial forecasts align closely, albeit in a conservative way, with management’s own projections.  A miss during the first 2 or 3 quarters suggests management’s ability to forecast isn’t ready for prime time.
In addition to hitting or beating analysts’ estimates, and really, “hitting” is the same as missing as all IPO prospects are
very strongly encouraged to launch with “in-the-bag” estimates, management of a newly public company is also expected to follow a strategy matching the one discussed on the IPO roadshow.  Public investors are right to expect that what they were sold on the IPO will closely resemble what will be delivered in the aftermarket.   Even the smallest variation from the model originally communicated can send investors racing for the exits and send the corresponding stock price into a nosedive.

Public investors are very different from VCs.  Sometimes, VCs can be forgiving, at least for a quarter or two, when something goes off track.  Public investors often will hit the eject button at the first sniff of an issue. What’s’ the difference? VC investors sit on a just a few boards and often spend years getting to know the details of their portfolio companies. This history allows them to put a misstep in context and patiently wait for the correction.  Well that and, generally, the investment is illiquid and can’t be sold anyway, which is fine because the VCs investors are locked in for 10 years. Contrast this with public investors who can concurrently be responsible for as many as 250 stocks and rarely have the luxury of taking a deep dive into the operations of the companies in their portfolios.  While VC report cards are made public rarely if ever, long-only fund managers see their grades in the papers or online every single day and can/have to make buy/sell/hold decisions every hour of every workday. When a newly public management team fails to deliver what was promised, the preferred course of action for a fund manager is to utter unkind things about the CEO and CFO, eject the stock from the portfolio and move along investments run by more credible teams.  As there really is no such thing as a one-quarter problem, this is almost always the right move.

And yet, sometimes, unexpected things do go bump in the night. When that happens, there are a few moves to make to perhaps cushion the inevitable fall.  The damage is done. The key is to regain credibility as quickly as possible.

 What follows are our suggestions.

1   Acknowledge right up front that the report does not match the forecast. Take full responsibility for the misstep.  Even if all the trains’ engines ran smoothly, failure to anticipate the log that rolled onto the track was a management blunder.

Management’s only smart move is to provide as much detail and transparency as possible (without exposing too much information to competitors, who will of course dialed in to the mea culpa conference call. The key is to demonstrate that the problem is well understood and the underlying issue identified. The CEO and CFO should expect an unpleasant conference call on which investors will ask very pointed questions. Management should be ready with detailed, data-driven answers.

2   Articulate a clear and credible plan to right the ship. Management should talk through the steps to recovery, the timing with which those steps can be implemented and a best guess as to how long it will take to see tangible evidence of the effectiveness of those changes. The following quarter’s earnings call is a very good time to tangible evidence of at least some progress.

     Demonstrate confidence in the plan.  Investors don’t actually expect companies to perform perfectly in perpetuity – there are zero examples of public companies that have never missed a forecast. Management’s job is to turn the bug into a feature, pull the team together and solve the problem. This is the time to show the mettle of management and to earn long-term fans in the investment community. It takes much more skill to sail a ship taking on water than to stay the course in a boat with the wind at its back. At this point, a smart management team will express confidence in the business, the team and the plan to get things back on track, no matter how long that might take.

     Execute on the plan in the time frame communicated.

     [Here is our ad.] Sometimes, it is difficult to communicate clearly in the middle of corporate nor’easter. Our role at Class V Group is to put our experience to work to help clients regain the confidence of the investment community and to communicate effectively, both in good times and when things go wrong. Some new issues never recover from a stumble. With the right help, others rebound quickly. We can help skew the odds in favor of the latter. Operators are standing by….