IPO: The Promise of a Payday?

An IPO is every startup's dream, but with crowdfunding and new legislation on the horizon, it might be better to focus on your business.
October 01, 2012

Kevon Saber, the founder of personal wellness application Fig, perhaps best encapsulates the reason why investors are ready to throw millions at a startup that goes public:

“Entrepreneurship is about achieving outrageous results with limited resources.” 

And for small-businesses owners taking your company public is an enticing dream. However, too many startups have mistakenly focused on that as the end-game, instead of perfecting their product, shoring up their customer service, or building brand loyalty and positive PR. Add to that today's volatile market, and alternative financing sources like crowdfunding, and businesses might want to think twice about the IPO—and focus more on getting back to basics.

The Mighty IPO

Today’s IPO is different from the IPO of years past, and it brings with it a whole new set of risks and rewards. Achieving an initial public offering was once the peak of existence for a few select companies. And then there was Groupon (GRPN), Facebook (FB) and Zynga (ZNGA). Facebook in particular debuted to investors in May 2012, valuing the corporation at more than $100 billion and setting an initial price of $38 per share. 

Photo: Scott Eells / Bloomberg via Getty Images

After spiking to $45 shortly after the opening bell, Facebook shares plummeted to $26. By August, when Facebook lifted the restrictions on share sales by its largest investors, the price was $19. In a matter of months, the technology juggernaut had lost half of its initial value. 

IPOs in 2012: A Valuable Proposition?

Given the recent highs and lows, the IPO environment is more exciting than ever. As soon as a startup is hyped in the media and on Wall Street, investors see an opportunity and everyone rallies around the company. Travel website Kayak, for instance, attracted significant attention when it debuted as a public company last summer after a long delay, and its IPO surpassed expectations. 

“The recent recession provided a low barrier to entry for people to invest,” says Kimberly Stone, founder of PoshGlam.com, a fashion marketing startup. Despite the fact that PoshGlam has reached critical mass with readership in 147 countries, Stone is not currently considering an IPO. However, she watches the market with interest and won't say for certain what the future holds.  “The IPO is a great environment for adequate long-term growth and return on investment. It is a good goal for strong, resilient and well-managed teams.” 

But is the environment stable enough for small tech firms that want to solidify their futures? Ash Kumra, co-founder of DreamItAlive.com (an online community dedicated to guiding people to live out their dreams) believes that an IPO should not be the objective of most startups. “Being private allows for more control in the long run and also provides a defined exit plan,” he says. “With an IPO, your results depend on too many factors that you can’t do anything about.”

Public companies face more ethical scrutiny and federal regulation than private ones. Saber also worries about the implications of offering stock to the public. “There are perils involved with serving short-term or misaligned investors you didn’t choose,” he says.

Saber would know.  A serial entrepreneur who founded three startups before the age of 30, Saber trained at the Stanford Graduate School of Business, and then failed at his first venture in 2001, succeeded with his second independently, and sold his third to a larger company. He is not currently considering an IPO for his latest initiative, Fig.

While most firms that pull off IPOs don’t start off profitable, there is no doubt that they are hugely successful. Tableau Software’s Daniel Hom found that, at the time they went public, 73 percent weren’t profitable. Hom also reports that 60 percent of tech IPOs made $100 million in revenue before going public. In other words, by the time you get to the IPO stage, you are no longer a startup or a small business.

Is Crowdfunding the Answer?

Crowdfunding, which involves selling small amounts of equity to many investors, may be a more feasible alternative for small businesses. Websites like IndieGoGo and Kickstarter have made it easier for founders to secure financial support.

Also, the American Jobs Act signed by President Obama in April included crowdfunding legislation that allows for a wider pool of small investors with fewer restrictions. The SEC is currently drafting federal rules that will make it possible for private startups to sell shares up to $1 million online, and will go into effect in 2013.

Kumra is excited about crowdfunding opportunities for DreamItAlive. “If crowdfunding is successful, it helps increase a company's valuation since it shows that a thriving community wants the venture to succeed,” he says. “It’s also a good option to get that first level of funding on the founders’ terms.”

Stone won’t rule out crowdfunding for PoshGlam either. “Crowdfunding is very cool,” she says. “It gives companies more options and keeps the decisions in the hands of the public. If they throw their money away, fine. If they get rich, hoorah! The American Dream is alive.”

Taking a Step Back

Many startup founders agree that companies considering an IPO may be getting ahead of themselves. According to Stone, effectively managing brand perception and PR should come first. “News plays a large role in hype and why people invest,” she says. “Companies like Facebook need to put a heavier emphasis on happier users and loyalty so that people want to evangelize the brand. If consumers are in love with the company, it will do well, but if there’s negative public sentiment or confusion, people will steer clear.”

On the financial side of things, Stone recommends that startup founders arm themselves with great advisors, surrounding themselves with smart people who fill their own voids in intelligence and understanding.

Kumra concurs, stating that once revenues start coming in, the savvy founder should hire either a full-time CFO or a consultant. But founders need to still be versed in cash flow statements and dilution. “Whether your goal is to build users or launch a new revenue model, cash flow management will be the most critical success factor for your business,” he says.

At a time when IPOs are still getting a lot of press, it’s tempting to get caught up in the frenzy. But, says Saber, realistic early-stage founders focus on shorter-term goals like solving customer problems rather than planning for a massive payday down the road. “Aside from understanding how investment capital impacts the company, learning the ways of Wall Street is not something startup owners should concentrate on,” he says. 

“Until a founder has solved a meaningful problem in a profitable way, she is distracting herself with the remote possibility that is the IPO."   

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Alexandra Levit is a former nationally-syndicated business and workplace columnist for The Wall Street Journal and the author of Blind Spots: The 10 Business Myths You Can’t Afford to Believe on Your New Path to SuccessMoney magazine’s Online Career Expert of the Year, she regularly speaks at organizations and conferences on issues facing modern employees. 

photo: Thinkstock