From the Ashes of Disaster Grow the Roses of Success

(Song  from the 1968 film Chitty Chitty Bang Bang, based on Ian Fleming’s novel by the same name)

No question, there are some ashes of disaster in the Silicon Valley Bank debacle. 8500+ people at various SVB entities are currently uncertain about their jobs and livelihoods, and sadly not at all uncertain about the value of their equity.  From every perspective the collapse of the Silicon Valley Bank, to put it mildly, is a very sad, very disruptive, just plain awful occurrence.

 

However, sticking with song titles, this is not the end of the world as we know it.  Many of those employees will recover under the bank’s eventual ownership structure, whatever that will be. Others will be snapped up by competitors trying to get a better handle on the magic that made SVB so important for so long. The companies that carefully saved money in deposit accounts at SVB, rather than say on an ego-trip Super Bowl ad, will find other places to stow that cash. In all likelihood, it is only the bank’s management that may well be cooked and, from everything we know so far, perhaps deservedly so.

 

But is this the end of Silicon Valley and ecosystem that spawns and grows innovative companies? Perhaps, the end of the county’s biggest engine of economic growth? That is surface-level thinking.  This is a big miserable bucket of cold water on the undeniably overheated economy that prevailed in start-up land until early last year.  When there is too much money in too many funds thrown with too much enthusiasm at too many companies, the timing is uncertain, the catalyst unknown, but the ending is a forgone conclusion and not a pretty one. 

 

However, the thing about being doused in a bucket of ice water is that after a good shake, it’s not that hard to warm up and dry off.  Just wait and see.  So shake off the panic, take a deep breath and look around. 

 

As many have stated for years and with clear evidence, this is not 2000, a time when, for many companies, behind the fancy website and astronomical valuation, there was no there there. Many of those internet darlings had optimistic slide decks and fancy-logoed t-shirts but not much (or anything) in the way of a sustainable business.  Contrast that with today when many still well-funded private entities have real products and services that real customers want.  These companies offer solutions to actual problems and therefore, compelling opportunities ahead.  For them, even before the SVB debacle, the sushi was already gone from the lunchrooms.  With the swoon in technology stocks, came an abrupt change in message from the boardroom from “Grow, grow, grow” to “Cut those expenses and aim for profitability ASAP”, a 180 that involves plenty of friction.  Painful ? Yes but do-able and in process.  Thanks to piles of cash raised in 2021, many have the runway to pull it off.

 

So we can check the first box. The ecosystem has spawned real products from real companies with enough resources to button up operations and soldier on.  Unfortunately, the challenge isn’t just about what can be controlled by the finance department.  Young company teams aren’t slaying a serpent, they are dealing with a Hydra. Specifically, while scrambling to adjust their operating M.O., these businesses also must contend with the incremental angst of ongoing macroeconomic uncertainty. In this environment, it is very difficult for long established companies to read the tea leaves and offer guidance with any accuracy. It is virtually impossible for younger businesses that have never been through one of these cycles to have a clue. Therefore, and quite correctly, many are being very, very cautious with their outlook for the next couple of quarters, hedging big-time on forecasts.  Of course, what follows cautious forward-looking commentary from public company CFOs is, inevitably, lower stock prices. And these "value adjusted" companies? They are also known as “comps”.

 

And that may prove to be the good news.

 

Macro uncertainty, a change in the focus of the operating model, dramatically reduced valuations may not appear to aggregate into compelling catalysts for the re-emergence of an active IPO market.  Appearances can be deceiving.

 

Until the SVB uh – event – many, not all but many, management teams and boards at private companies already at scale were content to rest on their balance sheets and proclaim the IPO simply won’t happen while valuations are wallowing beneath the sub-flooring. Stout treasury accounts and a renewed focus on cautious spending suggested that approach would work. Plenty of conversations this past 6 months that went like this: “Tighten up the P&L, heads down and when valuations come back, we will hit the public markets full speed ahead and bound for glory.

 

But that was then.

 

Everything changed last week when that virtual bucket – no tank - of ice water landed on the collective head of the Silicon Valley ecosystem (which by the way, is not geographically restricted to the west coast but rather every state that has any sort of entrepreneurial economy). 

 

Suddenly, the meaning of the old saw “hope is not a strategy” is painfully and irrefutably clear. 

·  The easy money is gone - for most

·  The relatively inexpensive lines of credit for “just in case” just got a lot more expensive and harder to land.

·  The venture funds, so recently at-the-ready to fund every AI (or other) entrepreneur knocking at the door as they scrambled to find opportunities to disperse the oversized funds they raised, have concurrently opted to yank back the reins.  Don’t call us; we’ll call you.

·  The balance sheet that looked plenty strong enough suddenly looks less certain. The days of “What, Me Worry?” have been replaced by sleepless nights and badly gnawed fingernails.

 

The times, they are a changin’.

 

But. but, but…… these are still real business with real opportunities. While growth may be slower, operating models for many are growing stronger.  Talented employees are more likely to stay put and, given the substantial layoffs of Q1 2023, it’s just a bit easier to selectively add to the teams.   These companies still want growth capital, solid balance sheets and liquidity. Reiterating: companies are still looking for, and to some extent now driven, to find liquidity.

 

Welcome back to the IPO market.  Q1, is about over and there was almost no IPO action. Q2 will be a time of continued adjustment and model re-alignment. By the time Q3 is over, many companies will have operating expenses under control, solid systems in place to measure outcomes from marketing, sales, engineering and overhead, a practiced ability to close quarters efficiently, and the painful recognition that stalling in hopes of attaining something near 2021’s valuation may be akin to sitting about waiting for a dude named Godot.

 

Some companies won’t get there from here. Plenty will.  They will take this pretty-shocking SVB wake-up call to spiff up the engine, check the oil, study the course and get the right driver in the seat, ready to put that pedal down when the moment comes.  About that timing…Will there be comfort about the direction of the economy and interest rates by Q3? Maybe. As 2024 will be an election year, it’s not unreasonable to assume the crystal ball will be less cloudy by then. 

 

Will valuations have rebounded? Maybe some, but to previous levels?  Nope. That shouldn’t matter.  The thoughtful, well-prepared teams will likely recognize that going public isn’t just about the price on deal day. It’s about a fully liquid market, a message of on-going stability, an enhanced treasury account and the opportunity to earn, not hope, the way back to a more fulsome market cap. 

 

How? Complete a smaller-than-originally-dreamed-of IPO, hit your forecasts, prove that yours is really a company, not a just a product or worse, a feature.  Demonstrate to the throngs of institutional investors with too much cash on the sidelines today that the management team understands the responsibilities and frankly challenges of being public, and remind your employees that the stock goes up only if the business delivers. 

 

You can’t win if you don’t show up and if you don’t get on the track, a competitor will take the pole position.  Management teams, looking at you. Now is the time to put fuel in the tank and rev those engines. Class V can help. The IPO market is coming back sooner than you may expect.

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".

Onward!

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.

Leslie's thoughts on preparing for an IPO in what may be a tough market....

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.

Are you REALLY ready to go public? A hopefully helpful guide to some key questions

2014 is in the books. It’s been a pretty terrific year in the IPO market. According to Renaissance Capital, through December 15, there have been 271 IPOs in the US this year, as compared to 221 IPOs a year ago at this time, a volume increase of 23%.  Thanks to Alibaba’s thunderlizard of a deal, the dollars raised by IPOs this year $ 84.2 billion exceeds last year’s total of $ 54.6 billion, by 54%%.  Not bad

Ah, but look deeper and you will see that actually, roses weren’t coming up everywhere. While 271 IPOs have been completed so far this year, conservative estimates suggest that more than 350 companies filed S-1s, a difference of nearly 30%.  For every 3 deals that filed and went public this year, at least one did the training, filed an S-1 and didn’t make it to the starting line.

Of course, we need to back out those companies that filed late in the year, targeting a 2015 transaction.  If we aggressively estimate that 20 fit that pattern, we still have more than 50 that didn’t get the job done as planned. When you consider the time and expense required for an initial filing, that is a big number.

What’s the difference and what price “Optionality”?

Bankers and others can be convincing when suggesting companies take advantage of the relatively new option to file confidentially: “Get on file now, then choose your timing later, but you’ll be ready.”  Factually correct? Yes. Good for your business, your P&L, your employees or your IPO?  Not so fast.  Preparing for an IPO too soon is neither a cost nor risk free option.

The on-going and elevated expense, distraction, loss of momentum and sometimes embarrassment (Box anyone?) that accompany a premature “go” decision can easily outweigh any timing flexibility benefits.  Picture the horses as they are led into the starting gate on Derby Day.  There is a reason they don’t load them until seconds before the bell.

OK, but IPOs do take a long time. How do we know when to start?

At January board meetings, following the “year in review” appraisals, many private company boards will have the “Is this the year to go?” conversation.  By “go”, we don’t mean begin internal preparations.  “Go” means schedule a bakeoff and hire bankers.  In advance of those meetings, we offer 5 questions every board should ponder before dropping the green flag.

1.     Can your sales and financial teams accurately forecast results for the next few quarters? Did you nail your forecasts last quarter?  If answering either of these is anything other than a rock solid “yes”, then take your time. Public investors show no mercy to companies that miss an early quarter.  Once you are in that doghouse, it’s a long slow climb out. Worse still, the brickbats that will come your way courtesy of angry investors are mere annoyances relative to the grenades your employees, customers and partners may lob through your door if you miss an early public quarter.  A swan-diving stock disappoints, creates instability and begs questions about  management’s reliability. It just takes one miss.

2.     Do you have the right team in place?  No really, are you sure you have the right team in place, not just for the IPO but also for the long term?  Step back and take a cold clear look.  The team that helped you get this far may be gifted, battle-tested and may be composed of friends. That doesn’t mean it’s the team for a fast-growing public company.   Public investors want to know that the C-suite in place for the IPO can scale the organization.  Newly public companies juggle enough knives when adjusting to the market’s spotlight.  There’s little bandwidth for concurrently integrating new senior leaders.  Save, time money and aggravation; line up the ducks before, not during, the process.

3.     Is your business model stable and ready for public scrutiny?  Admittedly, there companies (ex. Twitter) where even 12 months post-IPO the model remains an enigma. We grant that if your business has north of 200m active users, investors may cut you some slack.  However, for most, a more stable model correlates to a larger crowd of investors rallying around your IPO’s order book.   Are you hoping to migrate to a subscription model? Do you see significant price changes or regulatory updates on the near term horizon? Launch that new model or absorb the changes before you step on the IPO court.  In the eyes of investors, a foot-fault of your own making or because someone else moved the lines in a way you could have predicted, will cripple your stock’s performance and likely your personal reputation for a very long time.

4.     Are you ready for an intense audit?  There isn’t even a close second. The reason most companies on the IPO trail get thrown off course is because their audits aren’t ready on schedule. Audits won’t be rushed. The drill down scrutiny on every last decimal point is much more intense when your auditors know you’re preparing for an IPO.  We recently ran into IPO/ technical-accounting expert Barrett Daniels, Managing Partner of Nextstep Advisory.  He put it this way:

The reason an IPO audit takes longer than a typical private company audit is the dramatic increase in the risk profile. I assure you the audit partners want the audit to go quickly but they are, and rightfully so, going to take extra precautions to ensure the work is performed to endure the utmost scrutiny from the company, bankers, and ultimately the SEC.  The size of your audit team and number of questions will often triple during this process making for a robust and challenging process. 

5.     Is your company really strong enough to support the valuation you expect?  For this point, we will excuse readers at health-science companies, but for those selling products and services, not hopes and cures, size matters.   

a.     IPOs are expensive.  Bankers, lawyers, accountants, infrastructure and other service fees add up.  While most costs tied directly to the process are “one time”, other expenses including filings, higher legal and accounting bills and investor relations costs will be an on-going reality.  If the business isn’t able to comfortably absorb those charges, it isn’t ready to be public.

b.     Management teams tend to be optimistic. Bankers, reflecting experience, tend to be conservative.  Your finance team may produce a model projecting revenues over the next two years of $X and $Y. By the time bankers have helped you “refine” them, your forecasts (for the sell side analysts) will likely be closer $.7X and $.8Y. Expect similar treatment (opposite direction) for your expense projections.   It is those banker-adjusted numbers from which your initial valuation range will be determined.  Do the exercise in-house to be sure the projected valuation, based off a hacked-up model, will be acceptable before hiring banks and kicking off a process.  The more directly you face the conservative forecast reality, the better prepared you will be for the go/no go decision.

Companies need not score a perfect 5 to launch, but assessing answers to the hard questions upfront can profoundly improve the timing and reduce the costs of the IPO process.   Done right, an IPO can be a smooth, dare we say fun, stepping-stone to success.  A solid public launch not only enhances the corporate treasury but also an entity’s reputation, brand awareness, flexibility, competitive position and quite possibly, the rate of growth. 

The key, to paraphrase Kenny Rogers’ hit from yesteryear, “The Gambler”, is this:

“If your going to play the game folks, you gotta learn to play it right.”