By Nabi Menai
Today, Silicon Valley is synonymous with success. It is widely regarded as the modern-day cradle of innovation, not only within the United States but beyond. Mired with a myriad of successful technology companies such as Facebook, Google, and Oracle, there is no better place to be for budding entrepreneurs. The pull of Silicon Valley is magnetic and in many ways modern technology giants are thwarting the status quo.
One significant way in which many of these successful technology companies are challenging tradition is by waiting longer and longer to go public. The allure of the IPO seems to be fading within the technology sector, with more and more tech giants delaying their expected IPO dates.[1] Some public companies, such as Tesla, are doubting whether going public was ever beneficial given the regulatory and monetary hurdles that come with it.[2] Although there are legitimate pros and cons for delaying a potential IPO or never going public, the potential adverse effects delaying an IPO can have on a company’s value are worth exploring because of the resultant impacts on the national economy.
In recent years, having an initial public offering was seen as the apex for many up-and-coming entrepreneurs. To be listed on the stock exchange and have the public invest in one’s idea seemed like a dream come true for the aspiring entrepreneur. More importantly, it opened the floodgates to unprecedented levels of funding and a large cash payout. This aspect of going public, the fact that new and multiple investors would be able to help companies with their growth, was and is one of the prime reasons that companies consider having an IPO. But in recent years many startups and medium-stage tech companies have already secured gargantuan levels of funding, thus reducing the need for an IPO.
In recent years many startups and medium-stage tech companies have already secured gargantuan levels of funding, thus reducing the need for an IPO.
Saudi Arabia’s $3.5 billion investment in Uber via its Public Investment Fund is just one of many recent examples of unconventional investors providing exorbitant capital to emerging companies.[3] SoftBank’s Vision Fund routinely pours massive levels of funding into early and late-state technology companies as well and it shows no signs of slowing down in the near future. Many investors have quipped that “SoftBank has replaced the IPO” because of the amount of funding it provides technology companies such as Uber and China’s Didi Chuxing.[4] Armed with a fierce vision to invest aggressively and a surplus of cash, the Vision Fund has taken Silicon Valley by storm. This is just one of many reasons that IPOs have become less common in the technology sector.
Armed with a fierce vision to invest aggressively and a surplus of cash, the Vision Fund has taken Silicon Valley by storm.
However, one of the reasons why not going public is bad for the economy is because it inhibits more people from benefiting from the potential success of a company. Oftentimes this means that less wealthy people don’t get access to increased investment opportunities, usually only given to those who are well-connected and have greater financial security. This is because “only rich people can hand their cash over to venture capitalists and private equity groups to invest in young firms.”[5] As a result, the average investor is crowded out of a market only suited to those with wealth and savings. In turn, many Americans are shielded from reaping the benefits of the technology sector which continues to exacerbate the ever-growing income gap.
Perhaps the most salient concern pertaining to staying private is that it limits transparency in public markets. Because the disclosures that private companies have to make are much more restricted than those that are public there is “less information flowing into the financial ecosystem, reducing the market’s overall transparency,” according to Kara Stein who is a Securities and Exchange Commissioner.[6] When vital information is being hidden from the public it makes it more difficult to accurately gauge the value of a company, as well as asses how the market is doing. In addition, if there are too many private companies it could lead to a “deterioration in price discovery” among private companies.[7]
The level of transparency that an IPO demands is beneficial from the standpoint of the public as it has more to do with analyzing the financials of a company. For example, greater transparency also enables companies to mature by implementing “bylaws, independent directors, regular disclosure, and checks and balances on accounts.”[8] Management also becomes a central issue as the leadership of a company is under much more scrutiny. One of the clearest examples of this in recent times is the fundamental change in vision, leadership and day-to-day management at Uber which is planning to go public before the end of the decade.[9] The level of transparency and fiscal responsibility required for a company to go public means that when it is ready it “exudes an aura of confidence,” conveying to the public that “it has the governance and discipline to seek a fair return on investments and that it’s ready to accelerate growth responsibly.”[10]
Finally, if companies delay their IPO and go public later on in their life cycles, much of the growth phase (where most of the value is created), may have already passed and the company is then either too expensive or not worth investing in for the majority of people. This means that they miss out on a vital period of economic growth that they as participants could have contributed to. If this discrepancy is prolonged and repeated for multiple highly-valued companies, then wealth is again consolidated into the hands of a very small percentage of the population. While some argue that there is no need to go to the public markets for capital, private capital is still limited in comparison and not without a cost. Because there are far fewer investors, usually investments by a single entity are far larger and snap up a much larger portion of equity than a single investor in the public market could hope to ever have. This may lead to agency issues if one investor has a different viewpoint to management, and it also increases the chances of companies being turned out and sold for parts; Abraaj Group hotel investment is one such example. In 2018, according to Preqin, private equity as an industry had $3.06 trillion assets under management.[11] The New York Stock Exchange currently represents $18.5 trillion in market capitalization, 27% of the total market for global equities (global equities therefore are at 68.5 trillion).[12] This still means that for sustained growth, the public markets are far easier, and delaying an IPO could deflate how much capital a company may have access to (late phase with less potential for growth could negatively impact the IPO price). This would deflate the company’s access to capital and restrict incentives to create value for management. A primary way that public companies incentivize managers is by awarding them stock options and paying the salary in stock. If a company delays its IPO and there is not as much growth left in the stock, or even a potential decline, then management is less incentivized to advance the company’s interests and seek long-term growth.
In addition, because debt costs more than equity, and bonds have covenants that restrict the actions companies can take as well as the directions they want to move in, interest payments that need to be paid on time can become problematic when companies are still growing and burning lots of cash.[13] If these companies miss payments, they have to go through restructuring processes that they may not have the time or capital to go through or may even lose the company in bankruptcy proceedings.
In conclusion, while it is tempting to stay private to avoid the onuses that come with filing an IPO and the responsibilities that come with it afterward, there are several important reasons as to why going public, especially at a time when value is still being created by a company, is beneficial to the economy at large. Moreover, the requirements commensurate with going public are also incentives for companies to evolve, which is vital to the technology sector and beyond.
[1] Louise Lee, The Decline of the IPO, STANFORD BUSINESS (Apr. 12, 2018), https://www.gsb.stanford.edu/insights/decline-ipo.
[2] Gwynn Guilford, US Startups don’t want to go public anymore. That’s bad news for Americans, QUARTZ (Feb. 01, 2018), https://qz.com/1192972/us-startups-are-shunning-ipos-thats-bad-news-for-americans/.
[3] Arash Massoudi, Softbank: Inside the ‘Wild West’ $100bn Fund Shaking Up the Tech World, FINANCIAL TIMES (Jun. 19, 2018), https://www.ft.com/content/71ad7cda-6ef4-11e8-92d3-6c13e5c92914.
[4] Id.
[5] Gwynn Guilford, US Startups don’t want to go public anymore. That’s bad news for Americans, QUARTZ (Feb. 01, 2018), https://qz.com/1192972/us-startups-are-shunning-ipos-thats-bad-news-for-americans/.
[6] Louise Lee, The Decline of the IPO, STANFORD BUSINESS (Apr. 12, 2018), https://www.gsb.stanford.edu/insights/decline-ipo.
[7] Id.
[8] Amy Butte, An IPO Isn’t Just a Way to Raise Money – It Shows a Company Is Mature and Deserving of Trust, ENTREPRENEUR (Mar. 09, 2018), https://www.entrepreneur.com/article/309894.
[9] Mike Isaac and Michael J. de la Merced, Uber Turns to Saudi Arabia for $3.5 Billion Cash Infusion, N.Y. TIMES (Jun. 01, 2016), https://www.nytimes.com/2016/06/02/technology/uber-investment-saudi-arabia.html.
[10] Amy Butte, An IPO Isn’t Just a Way to Raise Money – It Shows a Company Is Mature and Deserving of Trust, ENTREPRENEUR (Mar. 09, 2018), https://www.entrepreneur.com/article/309894.
[11] James Comtois, Preqin: Private equity AUM grows 20% in 2017 to record $3.06 trillion, PIONLINE (Jul. 24, 2018), https://www.pionline.com/article/20180724/ONLINE/180729930/preqin-private-equity-aum-grows-20-in-2017-to-record-306-trillion.
[12] Id.
[13] Louise Lee, The Decline of the IPO, STANFORD BUSINESS (Apr. 12, 2018), https://www.gsb.stanford.edu/insights/decline-ipo.
