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What's more, Wall Street has outgrown smaller IPOs. Institutional investors have consolidated to a point that some of the biggest firms, such as T. Rowe Price and Fidelity, manage funds with hundreds of billions of dollars in assets. Behemoths like these might commit to large deals, but they don't bother with smaller IPOs, says Doug Gonsalves, who heads investment banking at ThinkEquity, which underwrote the recent offerings of OpenTable, Active Network, and Zillow. The investment opportunity isn't large enough, or the stock would lack sufficient trading volume.
As a result, the companies that are determined to go public must wait. Cornerstone OnDemand, a human resources software company based in Santa Monica, California, held its IPO on March 17—11 years after launching. The reason for the wait? Scale. Going public was part of the plan from the outset, says CEO Adam Miller. "We went public when we were able to attract top-tier banks," he says. "You have to achieve a certain market cap, or it's not interesting to them." In 2010, the company hired Goldman Sachs to underwrite the deal, which raised $136.5 million. Cornerstone estimates its revenue will be around $72 million in 2011.
By the time it went public, Cornerstone had revenue of $46 million, making it one of the smaller companies to IPO in 2010. Still, to reach that size, the company abandoned its original plan of financing growth through cash flow and took on two rounds of venture capital, one in 2007 and another in 2009. Taking on later-stage funding is increasingly common, says ThinkEquity's Gonsalves. But adding another round of funding also means ceding ownership and, in some cases, giving liquidation preference to new investors. That makes it more difficult for an entrepreneur to get a solid return on his or her years of hard work.
"I've invested a boatload of my own money into this, so there'd better be a liquidity event down the line," says one entrepreneur.
In addition to private equity, closely held companies also can take advantage of new marketplaces such as SecondMarket and SharesPost, which are designed to provide liquidity for shareholders in advance of an IPO. These markets assign a valuation to the company and allow well-heeled investors (participants must meet certain income or net worth requirements) to purchase shares from current shareholders. So far these markets have not been used to raise capital for companies themselves. But several social-media companies, including LinkedIn, Facebook, and Twitter, have used such secondary markets as a way to let employees exercise their stock options and bide their time while pondering or preparing for an IPO.
Some economists worry that the lack of access to public capital for smaller players could stunt economic growth and job creation. "This is a market in which Netscape and Microsoft could no longer go public at the stage that they did," says Reena Aggarwal, a professor of finance and business administration at Georgetown University. Sure, there's always private capital. But "the multiples you can get from private equity are much less than you could get on the public markets," says Paul Kedrosky, a senior fellow at the Kauffman Foundation, which recently unveiled a proposal dubbed "The Startup Act." Among the act's provisions: Ease access to public markets by reducing regulatory requirements for companies with market caps of less than $1 billion.
And yet for many entrepreneurs, the IPO remains the most prestigious rite of passage in American business. "It's the most exciting thing, the ultimate stamp of success," says Zach Nelson, president and CEO of NetSuite, which ranked No. 12 on the Inc. 500 in 2004. NetSuite went public in December 2007, one of the last companies to do so before the recession.
The longer road to the IPO means more pressure for entrepreneurs. But that isn't stopping the latest crop of young CEOs from trying. Schklair, of 3ality Digital, is one of the optimists. He acknowledges he needs to reach at least $100 million in revenue before he can get a suitable valuation, but an IPO will continue to be his goal. "I like the idea of building this company, and I think the IPO gives us the opportunity to build it further and take a little cash off the table," says Schklair. "I've invested a boatload of my own money into this, so there'd better be a liquidity event down the line." And if he has to wait, all the better. "We're in that steep part of growth—so we'll be worth a lot more."
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