The Balancing Act of Going Public - Weighing the Pros and Cons

In the dynamic world of business, taking a company public is a milestone that comes with its own set of advantages and challenges. My recent talk at the Web Summit focused on this intricate balance and how it influences companies like Stripe and others considering IPOs.Our session, featured by Maddyness, was further enriched by the presence of Rainer M?rkle, General Partner at HV Capital, known for seeding and successfully guiding Zalando and HelloFresh to their public debuts moderated by Elena Poughia, CEO & Founder Data Natives / Dataconomy Media / Dataconomy Media GmbH.

The Upsides of Going Public

An Initial Public Offering (IPO) can be a game-changer for a company. It opens the door to significant capital, which can be a catalyst for growth, expansion, or debt repayment. This move also elevates a company’s public profile, leading to new opportunities and partnerships. For early investors and shareholders, an IPO translates into much-needed liquidity. Additionally, for employees, stock options become a tangible and motivating incentive.

Interestingly, going public serves as a sort of insurance for the board and management team, ensuring the implementation of robust processes.

The Flip Side

However, the path to going public is strewn with hurdles. It's a costly and intricate endeavor, with ongoing expenses linked to compliance and regulation. Public companies also trade off a degree of privacy and control. They’re obligated to disclose financial details regularly and are at the mercy of market and shareholder expectations. This often results in a shift towards short-term earnings, overshadowing long-term strategic goals.

Market volatility can lead to fluctuating share prices, and the threat of hostile takeovers looms large. Moreover, in the current market, companies often face shrinking valuations compared to what they might have achieved previously.

Case in Point: Stripe’s IPO Timing

Considering whether Stripe missed its ideal IPO window during the tech boom (2018-2021), it’s evident that the company faced a complex decision. During that period, tech IPOs flourished, and Stripe might have reached valuations over $120 billion if going public and it would have been beneficial to its investors and employees. However, staying private has led Stripe to significant impacts, including a $4 billion tax bill from expired stock options and a fluctuating valuation, peaking at $95 billion but dropping to about $47 billion in 2022.

Comparing to Competitors

Operationally, Stripe's role as a transparent intermediary in a field where many competitors are public is noteworthy. When compared to companies like Visa, Mastercard, and especially Adyen, its closest competitor, the differences are clear. In 2022, Stripe's revenue was reported at $14 billion, compared to Adyen's $9.7 billion but Adyen (AMS: ADYEN) had a stronger EBITDA margin. Adyen, valued at around $30 billion and IPO'd in 2018, operates with fewer employees and likely lower costs, given its European base.? Adyen employs about half the people as Stripe, mostly in Europe (their HQ is in Amsterdam). It’s not just fewer people, but, most likely, lower cost per employee (European HQ vs US HQ, and the wage difference between the two).Despite lower rates and net revenue, Adyen realizes greater profits than Stripe.

The evaluation of Stripe's choice to remain private depends on future market conditions, growth trajectory, and its navigation of the digital payments sector. Adyen’s performance and strategy provide a significant point of comparison for Stripe’s future prospects in the fintech industry.

The Current IPO Landscape

Global IPO went from 2021 was the biggest IPO year ever - extraordinary volumes globally with $608bn raised to the steepest lump in 14 years in 2022. The tech IPO market is gradually recovering amidst investor apprehension due to factors like inflation, high interest rates, and geopolitical conflicts. The recent IPOs of Arm, Instacart, and Klaviyo indicate a cautious but present demand for IPOs, especially from profitable companies. However, I believe that a more vibrant IPO pipeline is not expected until late 2024 or early 2025, with the AI sector potentially leading a surge in IPOs.

Impact on Limited Partners (LPs)

The recent downturn in IPOs puts LPs in a challenging position. With the gap between private market valuations and public market realities widening, as seen with Instacart’s valuation drop from $40B valuation in the private market to a $10B valuation in the public market , investing decisions have become more complex . Many LPs still have a dominator effect, in which they are dealing with an overweight in private portfolios due to these high paper valuations of start-ups. There's a recognition that the high excitement of 2021 valuations won't return anytime soon. LPs are looking for liquidity now.

Many investors are facing pressure from their LPs to sell off their longer-held investments. For those investors who got in early, significant exits aren't always necessary to turn a profit and provide returns to their investors. However, the larger funds that have raised billions require substantial exits to yield typical venture capital returns. Many of these larger funds, having invested heavily at boom and peak market valuations, are now advising their portfolio companies to remain private and continue to provide bridge rounds of their companies due to these dynamics.

Numerous venture capitalists have refrained from resetting their portfolio valuations, lacking motivation to do so, especially when they are in the process of raising funds from the same LPs. In response, LPs are now adopting strategies like keeping more cash on hand benefiting from attractive interest rate and exploring secondary markets, providing them flexibility in this uncertain climate. This gives them a flexible way to sell their investments without waiting for an IPO. It's a Plan B for staying nimble in this uncertain investment climate. Occasionally, divesting prior to an IPO can lead to more favorable returns. For instance, Kleiner Perkins, holding a 30% stake in Zynga, received a $600 million distribution following the company's IPO. Meanwhile, Union Square, with a 10% stake in Zynga, obtained a $1 billion distribution before the IPO on the secondary market.

IPO Markets in Europe vs. the US

Many European companies, even established ones such as Spotify and the British company, Arms, often choose to list in the U.S. due to advantages like access to a larger investor pool, higher valuations, and more flexible regulatory environments. However, local listings in Europe, like Northvolt’s planned IPO in Stockholm, make sense for companies with a primarily European customer base and investor network.

Advice for Founders

In these uncertain times, we advise our portfolio companies to focus on cost reduction and efficiency to achieve profitability earlier. Staying private and strengthening key metrics before considering an IPO is prudent. Alternatively, exploring merger and acquisition opportunities is another viable path.

In conclusion, the decision to go public involves a complex evaluation of market conditions, company readiness, and strategic goals. As the landscape evolves, so must the strategies of companies and investors alike, navigating through the intertwined paths of opportunity and challenge.

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