A number of my colleagues have been asking why any entrepreneur would choose an initial public offering as an exit. They have a point: Even after the JOBS Act, the process remains heavily regulated and over-legalized; going public forces you to adopt a short-term orientation toward your business, since that's how your new co-owners think; and besides, there are now plenty of alternatives, ranging from crowdfunding to the secondary market for private shares. To complete the picture, most of the companies that have gone public this year are now deeply underwater.
No wonder the volume of IPOs is off 80% from 10 years ago.
What's going on here? When I put the question to AOL founder Steve Case in front of the audience at CED Tech Venture in Raleigh, North Carolina, on Wednesday, he vigorously defended initial public offerings. I was surprised, but perhaps I shouldn't have been. Case was instrumental in drumming up support for the JOBS Act, the bipartisan bill that, among other things, lowered regulatory barriers to going public. (Back in April, Case tweeted a picture of himself standing behind President Obama as he signed the bill into law.)
The reason that Facebook, Zynga, Groupon, and others have performed so badly, he said, was as much the fault of the rising private equity market as it's the fault of the public stock market. When he took AOL public in 1992, he pointed out, the company was valued at just $70 million, a fairly standard valuation for comparable companies at the time.
Recent IPOs have featured companies much further along in their development--and, more important, much further along in the growth of their valuation. The second market had helped drive prices of companies like Groupon and Facebook to fantasy levels long before they priced in the public markets.
To live up to those valuations, he said, "they had to execute absolutely perfectly once they got into the public market." When they didn't, they--or, rather, their new co-owners--paid the price.
Case hastened to ad that those recent results shouldn't sour company founders on going public. The JOBS Act makes the public markets more accessible to small companies than ever before by lifting disclosure hurdles and allowing companies to promote themselves more freely. Case points out that going public is still the best way to reward your investors and yourself, raise cash for expansion, and maintain your independence. (That is, again, if you don't mind sharing ownership with thousands of strangers with three-month attention spans.)
Case added that IPOs are also in the national interest. "More than 90% of job creation in this country occurs among companies after they go public," he said, repeating a statistic widely promulgated by the National Venture Capital Association.
You can see why VCs like spreading the idea that a liquidity event that makes them rich also is good for the economy. But according to follow-on research by the Kauffman Foundation, the claim overstates the value of IPOs by almost double.
In any event, you'd never take your company public simply because you thought it would stimulate the economy. That's taking patriotism a little too far.
Inc. 500 CEOs this year told us that they prefer the idea of selling to a private buyer over going through an IPO by a four-to-one margin. Jay Ritter, the University of Florida professor who worked on the Kauffman Foundation report, added some academic firepower to that preference, arguing that most small-growth companies are worth more as part of a larger organization that can add economies of scale, than they are as an independent publicly traded entity.
There are exceptions of course, and probably the most dramatic exception in business history is Steve Case himself. AOL went from $70 million at its IPO to $166 billion at its peak--a pretty persuasive argument for the upside of going public. Then, infamously, AOL merged with Time Warner--and over the next nine years lost 97% of its value.
Gaining $165 billion in value vs. losing $160 billion: It's just the sort of thing that could make a guy favor IPOs over mergers.