During these unprecedented times, one recurring question we hear from private companies is whether to go public now or wait till markets and society normalize. Since markets are by nature dynamic and constantly changing, we italicize normalize to emphasize that everything appears chaotic when timelines are reduced. That is not to diminish the current environment, nor the effects it has had on society, but to highlight that even without the COVID-19 pandemic, private companies still agonize over the timing of when to go public. That said, this week’s blog is not so much about the current environment, but an acknowledgement of the various factors to consider when deciding when to go public. Lastly, we recognize that every company is different and faces unique challenges. This list is in no way attempting to minimize those challenges, but to provide a framework that enables private companies to make a decision that puts them in a position to execute their long-term goals.
The one factor we will spend the least amount of time on but likely has the most influence is Market Conditions. No one would argue that when market sentiment is negative, the ability to execute a public offering becomes increasingly more difficult. Specifically, if public investor appetite for risk is low, less capital will be raised, resulting in lower valuations and increased shareholder dilution. In the worst-case scenario, demand could be so low that a deal just does not get done.
The second factor to consider is the Ability to Raise Additional Capital as a Public vs. Private Company. Following the excitement of becoming a public company and listing on a major U.S. stock exchange, executives and bankers often establish a plan to raise additional capital in the future that will allow the company to reach certain profitability milestones (EBITDA, Net Income, free cash flow, etc.). Given the increased disclosure requirements and transparency of quarterly financial statements (and annual audits), public companies can raise capital more quickly and efficiently now that they have access to all public market participants. Further, the cost of debt or equity capital for public companies is oftentimes lower, given increased transparency. Conversely, as a private company, raising capital can be time consuming and inefficient as private equity and venture capital firms require a full financial and business due diligence process to allow them to properly evaluate the company. Also, raising capital in a timely manner from private investors relies heavily on existing relationships, which significantly reduce the pool of potential investors and may result in suboptimal deal terms.
The third factor to consider is Corporate Readiness. Even if market conditions were optimal, we would strongly advise a management team to get as organized as possible to facilitate a smooth public offering. We break down corporate readiness into three buckets:
- Practicalities – Leading up to an IPO process, every company has structural and administrative tasks that need to be completed. For example, if a company has not done so, a major gating factor for filing documents with the SEC is having a third-party accounting firm perform a financial audit. Given the increased accounting requirements for public companies, it is prudent for private companies to hire the appropriate back office and logistical support staff well ahead of a public offering. Additionally, it is highly recommended to reconstitute the board of directors, prioritizing diversity and candidates with complementary expertise and a history of strong character.
- Wall Street Preparedness – In order for management teams to get off on the right foot, it is critical that they have confidence in their ability to forecast revenues. As a public company, a surefire way to lose credibility with public investors is to miss quarters and lower guidance shortly after going public. If a company is having a difficult time forecasting revenue and expenses as a private company, we recommend not testing the public markets until the predictability of the model improves. Conversely, if the business has a high degree of predictability, the focus should shift to developing a concise message regarding the company’s growth strategy. In doing so, it is recommended that companies provide a high-level analysis of their total addressable market (TAM), while utilizing reliable third-party sources. This last point goes without saying, but it is crucial for executive teams to be as prepared as possible when interacting with public investors for the first time. When an investor initially meets a new CEO and CFO, they likely will not have a long list of detailed questions. In fact, most meetings will be high-level in nature to get a feel for the overall business and the executive team. In order to make a good first impression, we advise management teams to commit to intensive Q&A prep sessions. This prep will pay off in spades as it will give CEOs and CFOs the added confidence they need to truly tell the company’s story.
- Changes in Model & Valuation – Given the current environment companies are facing in the midst of a global pandemic, it is safe to assume financial projections have been trimmed. As a result, companies need to understand what this means for valuations and target multiples within respective comp groups. This may impact valuations and bring them below a desirable threshold for existing investors from a dilution and palatability standpoint. Conversely, in thinking about public markets, companies want to avoid a situation in which they have limited investor interest due to valuation and technical factors, like float and daily liquidity.
The final factor to consider is Managing Public Investors vs. Private Board of Directors. As a private company, the board of directors likely consists of founders and representatives from the largest investors. While the number of board members is usually less than ten, the opinions of each board member can vary greatly depending on their individual motivations. For example, if Venture Firm ABC was an early investor and is looking for a liquidity event, they will be most likely pushing for a public offering or acquisition. Conversely, if Venture Firm XYZ made a recent investment, they will likely favor waiting to achieve a higher valuation with less dilution. While this example is certainly not unique, it demonstrates that board member incentives oftentimes do not align with a company’s intermediate to long-term goals. Unfortunately, operating during this period of debating whether or not to go public can lead to unintended consequences of mismanaging the business in the short-term.
Compared to managing private company board members motivated by a future liquidity event, public markets (while consisting of thousands of opinions) are efficient enough that they typically come to a consensus. Ultimately, public investors want a consistent and effective communications strategy with a level of transparency that allows them to grasp the risks of the business. If management can consistently deliver results based on what has been communicated, investors will reward the company with a premium valuation given the predictability of the business. If and when results fall short of expectations, the investment community’s reaction is far more forgiving than one might expect. While high quality investors realize that companies are not perfect and that quarterly misses are inevitable, they will not tolerate a message that is consistently contradictory to reality. While this might seem like an overly simplified explanation, the goal of management should always be to maintain credibility by telling the truth and preserving transparency.
As it relates to the COVID-19 pandemic, one common theme private company executives concern themselves with is the heightened interest that public investors may have regarding the impact of COVID-19 and how the company expects to come out of it. Most private company executives we talk to want to spend as little time as possible on the impacts of COVID-19 and as much time as possible on selling the long-term prospects of the company…and rightfully so. Interestingly, there is a misconception on the part of private companies that COVID-19 will dominate the discussion during an IPO process, resulting in a lower valuation. In reality, public investors will want to properly assess the company’s short-term risks but will place far more interest and value on the long-term prospects. Look no further than the rapid return to full valuations, the recent capital raises and IPOs across the medical-device sector. If management has done their job and properly communicated the risks of COVID-19, public investors will be more likely to look toward a more normalized 2021.
If you have any questions about timing your IPO or want a second opinion on your current strategy, contact our team today.
Matt Bacso, Principal