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GOING PUBLIC

Is the IPO Party Over?

The initial public offering has long been the ultimate goal of successful entrepreneurs. But now the decision to go public is much more difficult--and riskier--than it used to be.
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By all rights, Curt Richardson should at least be thinking about an IPO by now.

Richardson founded Otterbox, a maker of protective cases for iPhones and other handheld devices, in 1998 in Fort Collins, Colorado. Otterbox has more than 600 employees and saw its revenue soar nearly 200% last year, to $350 million.

An IPO could be just a few years down the road--except that Richardson has other ideas. "We aren't going public as long as I'm around," he says. 

Richardson says there are plenty of ways to get growth capital without resorting to an IPO. And from what he's seen of his distributors and suppliers, some of whom have gone public, an IPO has little to recommend it. Complying with public-company regulations is expensive and time-consuming. In some cases, he says, newly public companies become obsessed with short-term results at the expense of long-term strategy.

"My feeling is going public changes fundamentally how you run the company," says Richardson. "I know plenty of guys who went public who wish they never had." 

For some entrepreneurs, going public will always be their ultimate goal. "Every boardroom I'm in, the standard is still to create your own destiny, hit profitability, and ultimately go public," says Peter Nieh, founder and managing director of Lightspeed Venture Partners. "That remains the gold standard."

But more entrepreneurs are deciding that when the time comes, they would rather sell their company or merge into another one than go public.

"Being the CEO of a public company doesn't hold the same cachet for most individual entrepreneurs that it once did," says Paul Deninger, senior managing director at Evercore, a boutique investment bank. Venture capitalists looking to cash out of investments often have the same view, he says. "In the early 1990s, if I called a VC and said, 'I have a large-cap company interested in buying one of the better companies in your portfolio,' inevitably they would say, 'No way--I'm taking that company public.' Now, when I make that call, they say, 'Let me introduce you to the CEO.'"

A variety of forces have converged to make the initial public offering--long the ultimate sign of entrepreneurial success--less appealing. The continuing turmoil in Europe and slower growth in emerging markets make investors less likely to add risky young companies to their portfolios, says Sam Hamadeh, CEO of PrivCo, a New York--based research firm that specializes in private companies. The poor showing by the Facebook IPO didn't help, either. Then there are legal and regulatory issues that many entrepreneurs just don't want to deal with. 

But there is clearly something else--a cultural shift--going on. Entrepreneurs are still typically seen as innovators who are the key to restoring U.S. growth. But after the financial crisis of 2008, public-company CEOs are increasingly viewed with cynicism or suspicion. Why would someone want to go from being an innovator recharging the U.S. economy to just another greedy, overpaid CEO?

"It used to be that if the CEO of a private company had a choice of selling out for $500 million or going public at a similar valuation, the cooler and more respected thing to do was to go public," says Deninger. "The way CEOs are viewed today, more often they decide to just quietly take the money."

Entrepreneurs who can get good access to capital, who don't have outside investors and want to stay with their company until they drop dead, might try to stay private indefinitely. The rest have two options: They can seek a merger, or they can delay going public for as long as possible, giving them more time to prepare for the obligations of being a public company.

The Clear, Well-Traveled Path to Merger

For most entrepreneurs, a friendly merger is a lot easier to arrange than a delayed public offering. In 2011, there were only 125 initial public offerings, compared with 213 in 2007, according to Renaissance Capital, a research firm focused on the IPO market. In 2011, Renaissance found that those companies raised $36.3 billion, a 25% drop from 2007's $48.7 billion.

Meanwhile, mergers and acquisitions activity among smaller firms is booming. The number of U.S. mergers and acquisitions transactions valued at $500 million or less is on pace to exceed 2,000 this year. That's an increase from 1,013 in 2010, according to PrivCo. 

An acquisition has some clear financial advantages over going public. When a company goes public, insiders such as company founders are generally prohibited from selling shares for 90 to 180 days, a period known as the lock-up. The lock-up period used to be seen as a simple waiting game. Given the market's increased volatility since the financial meltdown of 2008, the lock-up period now presents a major risk.

With a merger or acquisition, says Tracy Lefteroff, global managing partner of the venture capital practice at PriceWaterhouse Coopers, "You don't have to worry about lock-up. And you know what the sale price will be. With an IPO, [those executives] don't know what the price will be when they are finally permitted to sell their shares, particularly now with the markets seeing such big swings."

Hold Your Horses

The other option is simply to delay a public offering for as long as possible. Thanks to some regulatory changes and exchanges such as Second Market, doing so is no longer as painful as it once was.

With the Jumpstart Our Business Startups Act--known as the JOBS Act--policymakers in Washington have made it easier to delay an IPO until a company is much larger. Under the new law, a company essentially needs to have 2,000 shareholders before it's required to file financial information publicly. The old threshold was 500 shareholders, and many say that were it not for the fact that Facebook crossed that number, it would still be private. Now that 2,000 shareholders is the new line in the sand, companies can delay public filings almost indefinitely.

There are good reasons to do so. It costs about $1 million to $2 million--and a big chunk of CEO time--to comply with Sarbanes-Oxley. So, the bigger a company is, the easier it is to absorb those costs. 

Once public, companies generally need coverage from Wall Street analysts to remain attractive to institutional investors. But the 2003 settlement between New York Attorney General Elliot Spitzer and investment firms, which was supposed to help eliminate conflicts of interest between banks' research and investment-banking divisions, had the unintended effect of greatly diminishing coverage of small companies.

According to New York--based financial markets research firm Tabb Group, the number of sell-side analysts fell about 7,000 from 2001 to 2006. "The [small-company] stocks can languish on the exchanges, because nobody is following them," says PriceWaterhouse Coopers's Lefteroff. "Big institutions won't invest in a stock they can't get research on. It becomes a real problem."

And start-up teams now have a much greater ability to pull some money out of their companies, even without an IPO or merger, than they did just a few years ago. Last year, some $8.2 billion changed hands on the secondary market for private shares, compared with just $1.6 billion in 2009, according to PrivCo.

Ain't What it Used to Be

Some venture capitalists say that even investors who prefer more mature companies might not be all that thrilled with the results of all this foot dragging. Speaking in July at Fortune's Brainstorm Tech Conference, venture capitalist and Netscape co-founder Marc Andreessen said that staying private is a "logical" move for entrepreneurs. But he also said that the trend toward delayed IPOs means that "the pension funds and a lot of the public participants don't get to benefit from the early growth of these companies, which is historically a big driver of returns."

"That's not to say that these companies won't perform well--many are still growing faster than the market average," says Bruce Gibney, founder of venture capital firm Founders Fund. "But these trends suggest that IPOs will be much closer to fully priced when they hit the market and that much of the growth will have been captured by private investors."  

Those private investors, of course, include entrepreneurs themselves. Such as Seung Bak, the co-founder of New York City--based DramaFever, which uses the Internet to distribute subtitled Korean television shows and movies to audiences in the United States and Canada. The 34-year-old launched the company in 2009 and is distributing content from seven Asian countries; he plans to add programming from South America. Bak has raised $8 million from venture capitalists and corporate investors, including AMC Networks.

"I have never had a serious discussion internally about going public," says Bak. "I think it only works for companies that are going to be really, really big." He expects that he will remain independent or sell DramaFever to a much larger company. As Bak says, "Going public isn't what it used to be."




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