Why do only unicorns seem to be going public?

Being a public company isn’t what it used to be. It’s now much more expensive and unattractive compared to 20 years ago.

In 2002, the financial markets and overall US corporate environment were reeling from the Enron accounting scandal. In the immediate aftermath, Congress wanted to ensure something like that never happened again, and passed Sarbanes-Oxley (SOX). This regulation imposed important additional reporting requirements on publicly‑traded companies, in an effort to increase transparency.

However, there are sometimes unexpected side effects to well-intended pieces of regulation… these new requirements now effectively impose a “compliance tax” (millions of dollars a year in extra accounting and other costs) to run a public company. Larger, mature companies are able to bear this cost easily; it’s much harder for small, growing companies.

In parallel, a new downside developed to having a public ticker: investors in public markets have become much shorter-term in their thinking and their holding periods.

On the other hand, a variety of regulatory and market changes have made it much easier to be (and stay) a private company.
  • The JOBS Act eased regulations for small private businesses and opened the doors to more money from individual investors
  • The low interest rate environment has investors chasing returns, and makes it much easier for startups to keep raising money at favorable valuations
  • Financing terms are relatively modest (low rates of multiple liquidation preference, participation, etc.)
Companies want to stay private, and the market and regulation has made it easier for them. This is why we’re seeing delayed IPOs – and hence more “unicorn” valuations – in Silicon Valley.

*  *  *

If you’re not convinced, let’s drive the point home with the following example.

Put yourself in the shoes of the CEO of a fast-growing, venture-backed tech company, with the following (example) projections.

Let’s say my CFO gives me the following three hypothetical options, what would I pick?

Option A – go public (this year or next year):
  • Raise $80 million for 10% of the company
  • Spend ~$4-6 million in IPO costs (up from less than $1 million twenty years ago… this will significantly impact my profitability and share price in year one)
  • Plan on ~$1-2 million in annual accounting costs for being public (which will be an ongoing drag on earnings)
  • Cater to an investor base that have become short-term thinkers (disincentivizing long-term thinking and investment in growth)
Option B – stay private for now and go public in 3 years:
  • Raise a private financing round of $50 million for 5% of the company, this year
  • Continue working with and reporting to my board of directors, composed of long-term investors and strategic advisors­­
  • With my strategy kept private, keep investing heavily in growing the business; this also means keeping control of the cap table even if it reduces liquidity for shareholders
  • Go public a few years from now, raising $200 million in an IPO for 10% of the company
Option C – stay private a bit longer, raise a lot more capital, and opt for a direct listing:
  • All of the above reasons in option B, plus:
  • Wait a bit until you hit profitability and positive cash flow
  • Eliminate IPO underwriting fees paid to investment banks (typically ~7% of the amount raised in an IPO)
  • Reduce your dilution, both from an artificially low valuation and from issuing additional shares in the public offering
  • Let the market set the price rather than fret and fear the right price to optimize the “Day 1 pop”

This is what we are seeing, time and again in the market. If your outcome is similar either way, wouldn’t you rather choose lower volatility and greater control, catering to your long-term strategic investors? Even if means lower liquidity for both you and your employees? It’s hard to imagine a CEO picking Option A instead of Option B. This is a core reason why companies are staying private longer and why we see so many companies with sky-high valuations today.

And if you have the staying power to wait until profitability, wouldn’t you pick Option C? This is why Spotify is leaning towards a direct listing, and a number of companies are watching that process as well.

Amazon went public 3 years and one private financing round after founding, when they were worth less than $500 million. We are unlikely to ever see that again.

This is no surprise, and no coincidence. Our own friend and investor Tim Draper, predicted the rise of unicorns before the term “unicorn” had even been coined.

Companies, their investors, and employees should all consider this as they plan for the future. This has had a huge impact on secondary markets in the last few years, and we’ll be breaking all of that down (and more) for you in the weeks and months to come.