Is it worthwhile to do an IPO during an era where Private Equity can invest considerably in the later rounds?
The business channel, Bloomberg, broadcasted a dispute of the advantages/disadvantages of IPO (Mark Cuban) vs. Silicon Valley (Andrew Romans) in today’s markets. Since I have witnessed first-hand the IPO process as corporate counsel, I feel that I can throw my 2 cents in.
Cuban stated that the advantage of the IPO is the liquidity afforded by the marketplace. Romans felt that there is enough liquidity in the VC world, even to the point that equity is exchanged among the Silicon Valley firms.
Let’s look at the different resources for transparency provided by VCs versus investment banks. First, the level of due diligence by a Wall Street investment bank overwhelms whatever I have seen in Silicon Valley. Some months ago, I visited a VC firm in Palo Alto that occupied a quarter of a floor of a small, nondescript building. It had no receptionist. And the meeting was populated by 2 personnel – one director and one analyst. Several months later that VC fund disbanded. The main entrance space, where the receptionist and waiting room would have been located, was populated by younger personnel, about 3, with their computer terminals.
The one director, I believed, was not qualified to understand medical devices, as his life experience was focused on semiconductors. During my presentation, I felt that they had not read carefully the materials sent earlier. So, maybe because of limited time, they never bother reading the complexities of the technology.
Now, let’s look at a Wall Street investment firm. In one meeting in a large conference room with a floor high screen, I counted over 9 analysts besides the managing director. One had a Ph.D. in finance from Harvard. All others attended top tiered business schools. True, a Wall Street engagement letter requires a retainer exceeding $50k a month to cover the due diligence process. But you see every penny being spent on high quality support. This bank has teams of writers, researchers, and PowerPoint experts that produce in less than a week a well drafted “Teaser” document with illustrations, statistics, not found in the business plan I had produced.
Moreover, they also bring in the top tiered accounting and law firms. The law firms’ production requests cover virtually every document needed. Accounting firms review every aspect of the company as well as the senior managers. Indeed, I actually noted that a CEO decided to move the company’s operations to Spain when the accounting firm needed to review his financial filings and taxes. As everyone knows, Spain has no extradition treaty with the U.S.
With the substantial vetting of any potential IPO, one has to conclude that their analysis and work really reflect the fact that they are avoiding any potential securities violations. Once a stock is public, there are litigious vultures waiting to see any “blood” or mistake to swoop upon.
What does Silicon Valley offer? A small club of investors protecting each other. Let’s take Yahoo, run by a local veteran from Google and Stanford. Over the course of her leadership in 4 years, she has single handedly lost the company over $20 billion, more than the GDP of some countries. Yet the small club mind set kept her on board while she laid off over 20% of her staff and she enriched herself last year with a $40 million payday.
Since by nature, all VC firms are thinly staffed, they are incapable of vetting the validity of a business plan outside of their comfort zone. And I have met virtually all of these firms and I noticed that all know each other’s activities and deals. There is a clubby atmosphere where each managing director knows each other, eat at the same restaurants, share the same innumerable panels. And they still lose in about 70% of their deals. One would be better off just flipping a coin to determine whether the investments will be successful. So the focus has been the inveterate leaders such as Uber, creating the mega-investments with the sobriquet, Unicorns. Yet, more money pursuing the same money has its limits. Sooner or later they need to diversify and sell some of that equity to someone else to share that risk. And this came out from Romans interview – the trading of equity among the VC “clubs, waiting for the right time to exit without an IPO. He admitted this fact to Cuban (putting his foot in his mouth), who commented that this intra-trading should undergo regulatory scrutiny. So now the clubby atmosphere is sharing more than golf game tees and the like.
So this Silicon Valley trend underscores what Cuban was addressing – the preference to use the IPO for liquidity where all transactions are transparent and small time investors can have access to equity that has been made squeaky clean by the SEC rules and regulations. Why is this important? Prior to the promulgation of securities laws, public trading was a wild, wild West show where the individual investors were burnt by stock manipulation and fraud. One such manipulator was the patrician, Joe Kennedy, a master at manipulating stock. When stock transactions are not so transparent and held by few, then those transactions can be subject to manipulation. What seems to confirm that observation is the fact that many Silicon Valley “highly valued” companies have been trading underwater since their IPOs.
The suggestion is that these companies were initially overvalued by the private firms, going for their exit strategy after the IPO, and that stock settled to its true value as determined by the analysts and performance, while providing the insiders the right to sell immediately after the IPO, and letting the unknowing investors to buy the overpriced equity. Mary Jo White, SEC Chairperson, has recently warned the public about this Unicorn excessive valuations.
So in the end, it seems that Cuban was correct that the IPO provides the best liquidity for secondary investors.