In the wishful thinking department there's no grease like easy money when it comes to the skids. So what's the deal? Are we likely to see a revival of IPO's as is being promised by a number of financial journals since Google decided to take the plunge? The answer, of course, is an unequivocal no! It takes the absolute height of a boom for new public companies to appear out of whole cloth.
So that's not the question we are going to deal with here. Let's, instead, examine what it is that makes the IPO market so attractive to ordinary investors and what they really ought to expect. The first thing to understand is that in IPO there are actually two broad markets, one pre-IPO and the other after the event. Needless to say, nearly all the big money is made in the "pre " market and most of the big money lost occurs in the "post" market.
So, what is it good for? Let's start with the positive: in investing high risk needs to be rewarded by high reward. In other words, if the kid down the street invites you over to his garage and gives you a demo of her latest hot idea and then asks you to throw some of your hard earned bucks behind it, well, your real chances of a payback are, let's say, infinitesimal. You're an "angel " in the vernacular and chances are your only reward will occur somewhere in the hereafter. VC's are supposed to be a little smarter, having been around the block a few times, and although they stick their own necks out, often they are mostly playing with other peoples' money.
Still, without them, most start-ups wouldn't ever get off the ground and the most dynamic part of our economy would probably end up like the hairy mammoth. In Europe, where VC's tend to play a much smaller role, it's the government through grants and subsidies that helps float new businesses. Whatever you think of politicians, and perhaps you have a higher opinion than we do, that's no way to seed an economy. A raffle would probably work better. And so, for all their warts and the distortions they often bring into play, let's grant that VC's take big risks and thus, on balance, deserve the rewards they pull out of the system, even if it comes out of the hide of the ordinary investor and often that of the founder(s) and early employees.
Because VC money is often crucial at an early stage and through the long voyage across the chasm, they wield enormous bargaining power. Founders often find themselves giving away much of their stake in order to keep the ship afloat. The VC's understand the game; lousy and mediocre ones often so distort the navigation system and ballast that long odds become impossible. Founders, of course, deserve the big payoff if it ever comes. They often spend years in the desert, scrape and claw, overcome enormous odds even before they have their first employee. Early employees also deserve major payoffs if the company does overcome the odds, and going public is one way this happens. Most start-ups rely heavily on stock option plans to hook and retain technical and managerial talent. There are a lot of problems associated with these plans but even here, on balance, the potential payoff does help early stage companies make it across that difficult period that Geoffrey Moore described as the "chasm ". Without them, it would get a lot harder to succeed.
But even here it's important to note that most employee stock option plans are written by the VC's and law firms who understand the process a lot clearer than your average guy, even in Silicon Valley. Plans commonly tie employees' hands at critical points by requiring long vesting periods and locks on when option holders can finally sell the vested shares they think they own. There are also cash flow, timing issues and tax traps, namely the AMT, that can turn paper profits into humongous tax liabilities. When it comes to stock option plans, they ought to be stamped like cigarette packs with a big caveat emptor.
Most companies never make it to the IPO stage and this may be a good thing for everyone involved. That's because IPO's are extremely expensive and time consuming. A company's management, often at a very critical moment (are there ever any non-critical moments for a new company in a hot, emerging market? you might fairly ask) becomes practically a prisoner of the IPO process for a period that can easily cover a year's time. Instead of worrying about competitors, business, critical research and development, they are thrown into a world of lawyers and bankers whose demands are all consuming. The founder and his chief managers get sucked into every facet, including the authoring of the prospectus. What's sometime worse, is the demands that the underwriters make on the company. Lean companies are required to beef
up their management rolls, often throwing delicately balanced team relationships into turmoil. Where everything was held to together by sweat and blood, now appears a new force, the suit with a resume. What's worse, these resume guys come straight out of central casting and have hefty demands that include big chunks of stock options further throwing delicate internal relations out of whack.
Then there's always the temptation to start the PR wars. Companies that once bargained hard for business cash flow considerations now abort the process so they can announce another deal, another strategic partner that looks good on paper. There is, in fact, nothing more contorting to the workings of a young company than the IPO process, as glamorous as it sounds.
Another longer term downer is the transparency that being traded publiclybrings to a company. Aftermarket stockholders have been given unrealistic expectations, and, as we will get to see, have almost by definition, terribly overpaid for those expectations. Now the company is expected to show its results for all to see on a quarterly basis. This usually means goodbye to strategic thinking, long term planning and hello to the world of gimmicks and skirting the law.
Let's remember that all of the pre-market players up to the underwriters and their friends do not require an IPO to get their rewards, a buyer with a good offer can come along and often do. Big companies are usually failures at creating really new business units and the smart ones know it. What they have is market power, management skills and resources. For them, the equation is a simple one. Sit around, wait and see who emerges and then scoop up the tiny percentage of winners at what seems like a premium price. Investors and unromantic prospective employees should be aware that companies where the founder is a major stockholder are not likely to get sold until it's too late and the premium has long been taken off the table. It's a matter of ego. This gal or guy has come up with the idea and pushed it along against all odds. Now, just when things are finally starting to take off the chances are that this same personality is going to imagine him or herself to be the next Bill Gates. Sell?, lose control?, not likely no matter how sweet the offer.
So who really benefits, the post market guy who buys the shares in the public market? Not likely. The sweet spot occurs right at the intersection
with Wall Street with the investment bankers. These guys get paid just for showing up and doing the work of launching the IPO. Further, they are the only ones to get to buy a lot of "unrestricted shares " still at the pre-market price, which, even in a hot market is equal to having the keys to the government printing presses. They get to reward friends and punish enemies and leverage this sure money to establish their power over the market. So, it's no accident that this is where all the shenanigans occurred in the late lamented last hot IPO market. A few companies like Morgan Stanley and CSFB got the lion's share of the market and they are, by the way, the same ones that are still in negotiations with the government as what the fines they are going to pay are going to amount to.
So if you are one of these investors who can't wait for the next IPO, take the word "laddering " and role it around the cobwebs of your brain. One of the things these companies are being fined for is the practice of "laddering ". What this means is that in order for a pre-public market investor to get his quota of shares, he had to promise to come into the public market on the first day and make a purchase at post market prices. Now why, you might ask, would anyone who got his shares at, say $15, want to buy more at say, $30. Well imagine what it does to the market to have a whole bunch of people coming in and boosting up the price right at this critical market when Mr. ordinary investor is beginning to lick his chops. Prices soar the first day, the headlines scream and lo and behold here come a whole other bunch of suckers in the second day. Now you got a Ponzi scheme.
Now if you've also got the megaphone of the press and the cheerleading of supposed analysts into the mix, you've got a bubble, baby! Are we anywhere close to an IPO revival? We don't think so. First, there's no next big thing. But that's a story for another day.