Study: Going Public Zaps a Start-up's Innovation
As far as exit strategies go, taking a company public has plenty of allure. After all, it promises a big payday for which you--and your investors--have been waiting, in addition to the ability to raise more funds as needed.
But according to a new study, an IPO comes with a much less desirable side effect: it poses a serious threat to your innovation.
According to the study, "Entrepreneurial Exits and Innovation" by Wharton management professor David Hsu and Vikas A. Aggarwal, a professor of entrepreneurship and family enterprise at INSEAD, going public stifles innovative thinking and a start-up's ability to take necessary risks.
"If you can stay private, you feel free to experiment more. No one's going to find out whether what you're trying to do is successful or less successful. You can aim for the fences more," Hsu notes in a blog post on Knowledge@Wharton.
The researchers tracked 476 biotechnology companies in the U.S., all backed by venture capital funding and founded between 1980 and 2000. They measured innovation according to the number of patents and forward citations--subsequent patents that mention the work of the innovator--filed during that time, which amounted to 15,400 and 45,800, respectively.
The study found the highest levels of innovation among privately-held companies. Firms that went public had the lowest levels, as patent and forward citation filings tended to drop off post-IPO. Start-ups acquired by public companies typically ranked somewhere between the two.
The factor that stifles innovation the most is the "public scrutiny," Hsu and Aggarwal found--and not highly talented employees cashing out. Going public introduces the pressure of reporting to shareholders and disclosing the company's finances. If the business doesn't see a nice bump in the stock price or deliver enough short-term growth, investors will get restless.
That, in turn, affects the company's goals. "You will have a shift in the types of projects you select,"Aggarwal says. "In a public setting, you have a much lower ability to take on riskier projects; you lower your tolerance for failure."
Why It's Better to Wait
The authors argue that CEOs who are committed to innovation above all else often resist going public all together.
They point specifically to Amar Bose, the founder of the eponymous audio equipment company, who refused to go public. Bose, who was also a professor at MIT, said during an interview with the Discovery Channel that going public "would have destroyed everything," meaning he would have had to focus on the company's image and stock price instead of innovations like "concert-hall-quality" audio. A New York Times obituary noted, "Dr. Bose was able to pursue risky long-term research, such as noise-canceling headphones and an innovative suspension system for cars, without the pressures of quarterly earnings."
A more recent example is Facebook. The authors argue that the timing of Facebook's IPO had to do mostly with the fact that it was approaching 500 shareholders--the legal maximum before a company must trade its shares publicly. "Technical reasons forced the company to go public," Aggarwal says. He also suggests that if Facebook hadn't gone public, it "would likely have had the luxury to be more innovative."
If you want to stay out of the spotlight and the pressure that brings, Hsu and Aggarwal say start-ups have other options.
One route is to sell to another private company, instead of a public one. But the key is to negotiate for "incentives and buffers" to protect your company's innovative spirit. Hsu suggests trying to structure the deal so that the acquirer acts as a sort of incubator. The ideal scenario is when the start-up can function as a separate entity and is insulated from the company's broader profit goals.
Tapping the right private equity investors can also serve as a buffer from the public eye and protect innovation. You might also consider building a partnership with a corporation. Hsu says that these companies often will trade funding for the marketing rights of your products.