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November 13, 2005

Public Company – Deciding To Do It

How do you know when to go public?  When’s the right time for your IPO (initial Public Offering)?  The truth is it depends on whatever everybody else is doing.

Pre Bubble 1.0 the rule of thumb was that a company needed at least three consecutive quarters of profitability before going public.  Even that was down from the previous rule of three YEARS. There had been some exceptions – primarily for biotech companies which presumably had very valuable patents.  By 1999 profits were “obsolete”.  Some companies which went public in Bubble 1.0 didn’t even have any revenue.

Discussions in many boardrooms, I’m sure, were like the discussion at the fictional antihacker software company hackoff.com in my novel of the same name:

*******************************************

Franklin Adams [he’s a VC and Board Member] is talking intently. It is what he is saying that's making Donna [she’s hackoff’s CFO] smile and dimple.

“Strange as it may sound, it's time to start preparing for our IPO. I hear that antihack is already talking to bankers and, if we’re not careful, they’ll get out ahead of us. I know this is a full year earlier than we initially planned;  I know we haven’t done all the things I said we’d have to do before we could go public — like get profitable or at least cash-flow positive. But that was then and this is now.  There’s never been a market like this one.”  Franklin sprays very slightly as he talks.

“It’s a huge distraction while we’re still building critical mass in our operations — still staffing up,” says Donna, without sounding argumentative.

“I agree,” Joanne [she’s a Board member representing Big Router Ventures who have invested in hackoff] answers Franklin, ignoring Donna’s intervening comment.  “Many of our portfolio companies are already public, some with less actual track record than hackoff. It seems they're all preparing to go. We may be behind.”

There’s a silence. “What do you think, Joe? [Joe Windaw is another VC and Board member]” asks Larry [hackoff Chairman and CEO] of the big man.

“It’s crazy,” Joe Windaw says. “There’s never been anything like it, probably never will be again.”

“So you think it’s too early?” Larry asks. “We should stick with the plan?”

“No, we have to do it now,” says Joe. “We can’t NOT take free capital when everybody else is doing it. We’ve got to go.”

“Even if everyone else is crazy?” Larry persists. “My mother would say ‘just because everyone else is jumping off a cliff would you jump off, too?’”

“Your mother was right about cliffs,” says Franklin. “But this is NASDAQ and this is now and now is different.”

*******************************************

Companies went public early for two main reasons:  their competitors were doing it and their investors wanted them to.  They didn’t go public to make immediate money for their VCs and founders, however.  Usually the bankers who handle the IPOs of unprofitable (more politely, PRE profitable) companies advise that “the market” will not be happy if anyone besides the company itself is selling stock.  Sophisticated buyers in an IPO do not want to see their initial investment going straight into the pockets of the founders and VC funds; they want to see it used to build the company.  Founders generally have to wait for a “secondary” stock offering – to be blogged later – for their “liquidity event”.  Quite often the holders of preIPO stock sign a lockup agreeing that they will NOT sell any of their stock in the company for at least six months.

It often is impractical for a company to refuse to go public if its competitors are doing so. Capital is a weapon and raising capital is an arm’s race.  Unilateral disarmament is not usually a good strategy. If your competitor suddenly has an extra $100 million of capital which pays no interest and never has to be paid back, you are going to be at a significant disadvantage unless you can get some of that cheap capital as well.

It is often also impractical to BE a public company before profitability – or even after, for that matter.  Public US companies are required to give detailed quarterly reports.  Investors in early-stage companies hang on every word in these reports and stocks soar and swoon based on insubstantial news or not-very-meaningful numbers.  Executive decision making is clouded by concern about the next quarterly report rather than being focused on the company’s long term growth.  Everybody’s attention – not just executives’ – is focused on the stock price rather than on customers or competitors.  SEC Regulation FD (Fair Disclosure) may require a company to expose its strategy for all –including competitors – to see.

Companies like Google and Microsoft didn’t go public until after they were profitable.  Certainly that’s not the only reason for their success.  But they grew to be fearsome competitors before accepting the constraints of public ownership.

Many of the Web 2.0 tools – and certainly all of the hardware – is much less expensive than software and hardware was just six years ago.  Web marketing can be very low cost.  So startups often don’t need more capital than their VCs are willing to provide

As I blogged here, Bubble 2.0 may be a better bubble because there is not – so far – a bloom of unprofitable companies going public.  Being bought out is, so far, the exit strategy of preference this time around. 

This post is about AT&T – scarcely a startup – sacrificing its future to help the current quarter.

This post and this one are about Reg FD and predicting earnings.

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