Two of the most influential thinkers in venture capital, Fred Wilson and Bill Gurley, today published brilliant essays encouraging venture-backed companies to consider an initial public offering.
The climate hasn’t always been so sunny for IPOs. Two years ago, Fred Wilson noticed that companies weren’t going public because of the regulatory environment, noting that “every time I sign a 10K or 10Q, my hand shakes a little.” Bill Gurley wrote that “no one wants to manage a public company.” Both acknowledged that IPOs were still a possible outcome, but not one on which most entrepreneurs should set their sights.
At the time, we acknowledged the risks but worried that the dearth of IPOs was itself less worrisome than the fact that investors of Fred and Bill’s ambition could accept it: “It’s like the PGA moved the Masters to a pitch-and-putt,” we wrote, “and Tiger Woods applauded the decision.” At issue was the size of the opportunity most companies faced, not just their regulatory or management challenges:
How many Web 2.0 companies today have a chance of reaching $100 million in revenues, then $500 million? Maybe we have the next Google, eBay, or Amazon among our ranks now. If so, I doubt the new regulations are enough to deter them from growing into public companies. Characterizing folks who cash out as just smarter or more realistic than those who want to build a stand-alone business seems just as misguided as the 90′s macho insistence on an IPO for its own sake.
Today, in a post titled “Bashing the Collective Wisdom on IPOs,” Fred pursues that theme, describing in detail the rare kind of company that should now consider an IPO: a market-leader with sustainable profits and the ability to grow beyond a billion in revenue. And Bill convincingly makes the case that demand for IPOs is now so great that public investors will pay a premium for new high-technology stocks.
This isn’t by any means a repudiation of their earlier stance, but it certainly reflects a new enthusiasm for IPOs based on improving capital markets, and probably signals broader acceptance among early-stage investors for companies with IPO aspirations.
It’s good to see the IPO begin to make a come-back. Truly disruptive companies often have business models so different from any potential acquiring company’s that no one would buy them anyway except for scrap: Amazon couldn’t have thrived under Barnes & Noble, and Netflix might have gone down with the Blockbuster ship. For the same reasons, Redfin doesn’t want to get bought by Century 21.
Build for the IPO, Even If It’s the Least Likely Event
Hopefully this will change how startups think from day one. In the two years since high-tech IPOs reached their nadir, the conventional wisdom has been that the safe course was to build companies to be acquired. I have seen dozens of startups follow this advice: increasing traffic not revenue, building add-on features rather than their own products, and avoiding hires that wouldn’t be valued by an acquiring company.
Some got bought. Most didn’t. The ones that didn’t had a glum future: neither investors, management nor the employees were in it for the long haul, and the company hadn’t given much thought to generating enough revenue to become profitable.
The moral of the story is that you can’t show up to a track meet prepared to run a mile, only to find out you’re in a marathon. Rather than building for an acquisition and hoping for an IPO, you have to build for the IPO then accept an acquisition when that’s the outcome that makes sense.
Even if the overwhelming majority of startups will end up getting bought — I don’t think Redfin is in this category — the best way to command a high price is to be self-sustaining and independent, so you can win your market outright and control your own destiny.
Don’t believe me? Just ask Sujal Patel at Isilon, a Madrona investment that never could have commanded a $2.25 billion price from EMC if it hadn’t taken the time to build itself into a great company in its own right. Or ask an old roommate of mine, who once suggested I cut my toenails before a date.
“Why would I do that?” I asked.
“You know,” he said, looking at me uncertainly. “It could be a long night. You just want to be ready for anything.”