Martin Zwillingm, Jul. 4 2011 - 7:53 pm
Manyentrepreneurs still dream of “going public,” making billions of dollars, and playing with the big boys. They don’t realize that this option would likely be their worst nightmare, since it costs millions for the road show, usually dilutes your equity to a tiny fraction, and takes away all your entrepreneurial control.
Even though the Initial Public Offering (IPO) alternative for a successful startup seems to be coming back into vogue, it is still extremely rare. Only about a dozen U.S. companies made the IPO transition in 2009, out of thousands of startups. Even in most of these cases, the original startup founders were pushed out, or heavily supplemented, with “experienced” executives.
Sure, there are examples of founders who have survived and prospered, such as Bill Gates and Larry Page, but these guys are the exception, not the rule. More importantly, you should never even start down this path unless you can really use a large infusion of $150 million in cash or more, and have $3 million in the bank and up to 18 months to dedicate to the effort.
I recently reviewed a good summary of the advantages and disadvantages of an IPO exit strategy for startups in a widely-used textbook “Entrepreneurship,” by Robert Hisrich, Michael Peters, and Dean Shepherd. Their synopsis of the key risks should make you look hard for an alternate exit strategy:
- Increased risk of liability. With Sarbanes-Oxley, the CEO, CFO, and the Board of Directors are all assumed to have full knowledge of all government standards of compliance and reporting. All are charged with personal responsibility and liability for reporting and public disclosures, backed by huge penalties, fines, and prison terms.
- Higher administrative expenses. Most estimates of the expense for compliance and accounting procedures of a public company are at least double, or maybe quadruple those of a private company. Expensive new IT systems, consultants, and investment bankers are usually required.
- Increasing government regulations. Just to keep track of new regulations and changing compliance requirements, many companies have added a new bureaucratic tier and a chief compliance officer, as well as more expensive lawyers. Annual reporting and audit requirements continue to increase.
- Disclosures of information. With public shareholders and high liability risks, every public company must disclose and answer to shareholders and the press on all material information regarding the company, its operations, and its management.
- Pressures to maintain growth pattern. Opening your company to the public will change the way you do business, from reinvesting returns for the future, to maximizing growth each quarter. The pressures to maintain growth patterns and meet the expectations of the investment community are typically real and intense.
- Loss of control. When shares are sold to the public, the company starts to lose control of decision making, which can even result in the venture being acquired through an unfriendly tender offer. With the more popular Merger & Acquisition (M&A) exit strategy, the control stays with the new entity.
On the other hand, if you are looking for major financing to expand manufacturing capacity, or need major marketing efforts to build your brand, an IPO may be the only way to get you there. Of course, IPO funds can be used to finance a big development effort, but the delay in payback will likely cause a quick stock price decline, which invokes the challenge of continuous growth mentioned above.
In any case, an entrepreneur in one who likes to build new products or services, and works ON their company, while a public business executive works IN the company. Once the new startup is “proven,” most entrepreneurs are happy to exit, before being forced out or burned out, to start again with a new and even bigger vision. Don’t be driven by greed to the wrong alternative.