An Initial Public Offering (IPO) is when a company makes its shares available for public trading to raise capital and enhance visibility. When a company initiates an IPO, it follows a conventional process to be listed on a public exchange and secure funding. They are often portrayed as the key milestone for growing companies, symbolizing maturity, success, and market validation. Entrepreneurs are often attracted to the IPO option because, when executed correctly, it allows them to leverage public market funds to support other areas of the business, such as Research & Development. However, this approach can be a short-sighted and might harm your hopes for an Extraordinary Exit.
Here are five common misconceptions about IPOs.
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2. An IPO is the only way to drive leverage
3. Founders will receive more money from an IPO
1. IPOs happen all the time.
Despite the high visibility of IPOs in the media, they are relatively rare events. The perception that every successful company inevitably goes public is misleading. According to the StockAnalysis, there have been 83 IPO’s so far in 2024 in the U.S. stock market alone. Comparatively in the global M&A industry as reported by PWC, in the first half of 2024, deal volumes were just over 23,000 and deal values reached $1.3tn. In reality, many companies choose to remain private or look at alternative, more suitable exit strategies.
Strategic exits, where a company merges with a larger entity, can often accelerate growth and propel the founder’s vision forward as well.
2. An IPO is the only way to drive leverage.
Entrepreneurs often believe that IPOs are the best way to increase leverage and gain access to capital. The perception is that if the demand remains strong, the IPO’s opening trading price will surpass its offer price. However, this isn’t always the case. Nasdaq reports “An average gain of 18.4% on day-one makes IPO investing sound like a pretty attractive investment strategy. However, 31% of IPOs actually fall on their first day of trading compared to their offer price. Additionally, nearly 50% of IPOs fall on their second day of trading (versus their day 1 close).”
There are more options available to your business that could still provide you with the capital injection you need. One of these is to consider selling to a publicly traded strategic partner. This approach still allows you to leverage the public markets dynamics, as their stock price appreciation can offset costs within your business. By partnering with an established public company, you can benefit from their stability and extensive market experience, navigating the challenges that come with a traditional IPO more effectively.
3. Founders will receive more money from an IPO.
The idea that an IPO ensures large financial gains for founders can be true but can also add complexity. Factors such as stock price volatility and the founder lock-up period can result in lower-than-expected returns, with stock prices often dipping after the initial offering, as mentioned earlier.
A lock-up period occurs when a company goes public, during which internal investors may be prohibited from selling their ownership stakes. This period typically lasts between 90 to 180 days.
Even for IPOs that initially perform well, approaching the end of the lockup period can introduce risk, as insiders and other stakeholders may begin selling additional shares. This increase in share supply can drive down stock prices, especially if demand for the shares drops at the same time. Ultimately with a lock-in period, you’re selling on a timeline that you don’t have control over. While shorter lock-up periods, typically within the first three to five years post-IPO, may yield favorable outcomes, extended periods exceeding 10 years can lead to significant declines in share prices, potentially resulting in financial losses upon exit.
Considering alternative options, such as selling to strategic buyers through an M&A firm like STS, offers many advantages. Strategic buyers often recognize the long-term potential of acquisitions, fostering a perspective that prioritizes sustained returns on investment. This approach ensures that both sellers and buyers can maximize the full value and potential of the transaction.
4. Timing doesn’t matter.
Timing is crucial for a successful IPO. You need to consider the market conditions, economic cycles, and industry trends, to predict a favorable outcome. For example, the tech boom of 1999 was a favorable period for IPOs, while the post-2001 market crash and the COVID-19 pandemic were not. Considering the preparation period to go public can take up to a year, the business and market conditions can change radically in your lead in time, and you may miss your window of opportunity.
Selling to Strategics, on the other hand, allows you to begin preparing for an Extraordinary Exit two or three years in advance. The ideal buyer will seek to acquire your business to achieve specific strategic goals, such as expanding their product lines, entering new markets, or gaining competitive advantages. Their decision to buy is primarily driven by how well your company aligns with their strategic objectives and the value it adds to their existing operations. This focus on strategic fit and value makes the acquisition process less sensitive to broader economic fluctuations.
5. IPOs don’t vary by region.
When considering an IPO, the choice of stock exchange and the region you are in can also impact the success and perception of your offering.
For example, listing your company on a reputable exchange can enhance visibility, liquidity, and investor confidence, potentially leading to higher valuations. Conversely, other stock exchanges may specialize in industries like natural resources and mining, attracting companies from those industries but potentially limiting appeal to a broader investor base.
Emerging stock exchanges aim to establish themselves over the next five years. While these new exchanges may offer lower listing fees and less stringent regulatory requirements, they could initially face challenges such as lower liquidity and visibility.
Other stock exchanges can sometimes result in a company being perceived as higher risk. This perception often deters institutional investors, who might categorize such listings as speculative, thereby limiting potential investment and impacting the stock’s performance.
Case Study: The Double Leverage of Strategic Acquisitions
There are notable instances where selling to a strategic, particularly a publicly listed firm, has proven highly beneficial. Consider companies like RelateIQ, acquired by Salesforce, and LinkedIn, acquired by Microsoft. Despite not yet achieving full maturity or substantial relative profits, these acquisitions proved successful as the purchasing companies leveraged their broader market reach and increasing stock value to amplify the deal’s financial impact multiple times over. This dual benefit illustrates how strategic sales can offer a lucrative and comparatively less risky alternative to pursuing an IPO.
“In my experience, the decision between Selling to Strategics or an IPO comes down to the ability to achieve an Extraordinary Exit on your terms. Often founders want maximum value and maximum impact. The place that allows for that most often, is selling to a strategic buyer where you will most likely reap the rewards of your efforts in your required time.” – Shamil Hargovan, STS Managing Director.
When considering your options to achieve an Extraordinary Exit, selling to a strategic buyer through STS Capital offers many advantages over pursuing an IPO. STS’s strategic sell-side only approach enables us to target the right strategic buyers and emphasizes your unique, integrated value to deliver the maximum financial value for your business. Strategic buyers prioritize your company’s unique value and alignment with their strategic goals, minimizing reliance on economic fluctuations and investor sentiment. This approach mitigates the risks and uncertainties associated with public offerings, where market conditions can significantly impact stock performance and company valuation.
