CREDIT: Illustrations by Zohar Lazar
An IPO is the dream of many–but it doesn’t always mean a happy ending.
It doesn’t sound like the start of a crisis. Last year, HomeAway co-founder and CEO Brian Sharples decided that his company needed to spend more money on marketing. It had been a few years since the online vacation-home-rental marketplace, which became publicly traded in 2011, had forcefully invested in its brand. Meanwhile, Sharples had watched competitor Airbnb become synonymous with the business of home-sharing, amassing a whopping $25 billion private valuation along the way. HomeAway suddenly seemed like an underdog.
Now Sharples thought it was time to remind customers that HomeAway had long been a market leader. So at a midquarter conference in May 2014, he hinted at his long-term plans: Look to us “in the next several years to get more aggressive” in marketing.
Shareholders hated the idea, worrying the expense might eat into margins. Days later, J.P. Morgan downgraded HomeAway’s stock, and the share price, already slumping from earlier that year, tumbled even lower. For the next few weeks, Sharples spent at least a third of his time on calls with anxious investors and analysts, who wanted to know, among other things, how much the company planned to spend on brand marketing versus performance marketing–splashy image campaigns versus highly trackable things like online search. “I’m not ready to talk about that,” Sharples would say, reasonably enough. The company hadn’t yet determined the exact mix.
“Well, if you’re doing brand marketing, that’s going to be really bad,” a banker on the line would tell Sharples. Not bad for the company’s growth or underlying business, though: “Just bad for the stock in the short term, because it has a long-term payoff,” the banker would continue. “And we manage investments on a quarterly basis, so if we think the stock is going down this quarter, we might as well sell it.”
It’s easy to imagine Sharples wanting to bang his head against a wall at that point in the conversation. Even after he clarified, at the end of the quarter, how the company would pay for the effort without compromising margins, the results would not be in for a full year. This spring, when HomeAway’s heartstrings-tugging “Whole Vacation” ad campaign started running, the investment began to pay off: The trade press approved, and brand awareness and traffic have grown in the months since then, Sharples says. By all appearances “Whole Vacation” was a success; in the week the campaign rolled out, HomeAway’s stock price even jumped 7 percent. (In mid-August, the stock was trading around $31 per share, where it’s hovered for much of the past 18 months.)
Where Sharples went wrong was in the messaging. By announcing his plans midquarter, rather than during the highly ritualized end-of-quarter conference calls, he didn’t provide enough context for the strategic shift, and the story took on a life of its own. “Here’s the issue about being a public company,” Sharples says. “If you’re private, you just make a decision. You don’t have to tell anybody.” But when you’re public, you do have to tell people, and include some details: “If you’re going to telegraph decisions,” he says, “analysts need numbers to plug into their models.”
It seems like such an insignificant mistake. But it’s one of many unexpected complications that entrepreneurs confront when they emerge on the other side of an IPO. In an age of dizzying investor strategies, costly and complicated regulatory requirements, and 24/7 media coverage, the challenges of running a public company are trickier than ever.
There are a lot of reasons to go public, of course–raising a big pile of cash not the least among them. Even the simple sense of legitimacy a public company gets, a sort of graduation into corporate adulthood, can be a meaningful advantage. But founders who, like Sharples, recommend crossing that public-private divide have plenty of cautions about life post-IPO. One of them, Zulily co-founder Darrell Cavens, just decided to relinquish his company’s recently acquired public status; as this article went to press, Zulily agreed to be sold to QVC owner Liberty Interactive Corporation.
Other founders are increasingly unenthusiastic about the once-vaunted prospect of going public. The busy IPO market of 2014 cooled this year, as many of the largest startups have chosen to raise ever more rounds of private capital, joining the so-called unicorns with billion-dollar-plus valuations (though, eventually, those companies will have little choice but to try to go public). And then there was Alibaba founder and CEO Jack Ma, who raised $25 billion last year in the largest IPO in history, telling a New York City audience in June, “If I had another life, I’d keep my company private.”
Some fast-growth companies, like email-marketing service provider MailChimp, plan to remain resolutely independent. (Its bootstrapped roots will make that easier.) “The only reason any sane entrepreneur would go public is if the investors needed an exit,” says MailChimp co-founder Ben Chestnut.
There’s no one right path for sure growth, of course–and for many founder-CEOs, the headaches of being public are worth it. But if you’re considering following in their footsteps, their warning is clear: Make sure you know what you’re getting into.
Warning No. 1
Rumors Become Reality
Even for a high-flying stock, the market holds constant perils. Take GoPro. For a few months, the mountable-camera maker with a rabid social media following seemed to have handily won its IPO. GoPro debuted in June 2014 on the Nasdaq at $24, and within a week shares were trading for twice that amount–and they only kept climbing. The stock eventually reached a closing-price high of $93.85 in early October 2014, which valued the company at almost $12 billion. Founder and CEO Nick Woodman, who bootstrapped GoPro’s launch 12 years ago on a surf safari in Australia and Indonesia, was suddenly worth more than $5 billion.
It was short-lived; the market started tanking, and then something happened that nobody could have expected. Last October, French journalist Jean-Louis Moncet reported that a GoPro product had been responsible for the severe head injury and subsequent coma suffered by the legendary Formula 1 racecar driver Michael Schumacher, among the world’s most famous athletes. Schumacher had crashed into rocks while skiing off-course in the French Alps; he’d had a camera attached to his helmet, and Moncet wrote that the mount had compromised his head protection. Over the next few days, GoPro’s stock plummeted more than 10 percent.
The report turned out to be completely false–Moncet later said he was speculating–but the damage was done. GoPro’s stock, down from its high following the overall dip in the market, only inched back up.
Over the past year, GoPro’s stock fell to as low as $38–40 percent of its onetime high–before beginning a steadier, less frenzied climb than its initial pop. (As of mid-August, the price was around $60.) Ever the surfer, Woodman has tried to keep a cool head, despite watching hundreds of millions ebb and flow, as speculations fly online about everything from the company’s long-term viability to, well, German racecar drivers. “We can’t be responsible for the whims of the market,” he says. “We have no control over that. We do have control over following through on what we say we’re going to do, and whenever possible, exceeding expectations.”
Whether or not a stock’s price is affected by insidious forces doesn’t change the effect. Whatever the reason, the new price is what it is, and the CEO’s job is to build it up from there. Woodman found a hidden bright side to GoPro’s tumble after its initial rise: that the kind of long-term investors the company wants saw it as a great opportunity to buy.
5 percent: The average amount of a company’s value eaten up in the IPO process, between fees paid to investment bankers and the money not raised if the offer price is less than what the company could have gotten, as it usually is. “For a company with a price-to-earnings ratio of 20, that’s an entire year’s worth of income,” says University of Florida finance professor Jay Ritter.
21 percent: Average share-price pop, or first-day return, for IPOs completed during the first half of 2015, according to Ernst & Young. As Ritter points out, that means most companies’ IPOs are priced too low.
One explanation for disproportionate stock-price movements is simple groupthink. GoPro may or may not be worth $94, but when a stock is hot, a lot of people want in. Likewise, when bad news hits, people run for the exits, sometimes en masse. This makes sense, of course, but it can go from disproportionate to devastating pretty quickly with the help of underhanded investors–say, short sellers who have an interest in seeing the stock price fall quickly and who might make the most of bad news or rumors.
And then there are the outright fraudsters. “Misinformation is always put there for a purpose,” says Chris Hodges, the CEO and founder of Chicago-based investor-relations consultancy Alpha IR Group. “Especially if you’re a high-profile stock, you’re a target.”
Just ask Avon and Twitter, victims of absurd recent examples of suspected stock manipulation. Both companies had received buyout offers that drove up their stock prices–at least until the offers were revealed to be fake. In Avon’s case, the scammers legitimized their “bid” by filing official regulatory documents with the federal government; in Twitter’s, they created a counterfeit version of the Bloomberg website to report the supposed offer.
Private companies can also be attractive targets for rumors or deliberately placed falsehoods, of course. But the damage from post-IPO rumors is much more visible–thus often much more distracting.
Lesson: You can’t fight the rumor mill, whether your company is private or public. Follow Nick Woodman’s example: Keep calm and carry on.
Warning No. 2
Everyone Wants Answers–All the Time
“The role of the CEO changes in public markets,” says co-founder and CEO Cavens of the kids-focused flash-sales giant Zulily, which raised $253 million in a much-watched IPO in November 2013. In August–less than two years later–Cavens agreed to sell Zulily in a $2.4 billion deal, with the new owner keeping him in charge of the business. Before that deal was announced, Cavens had told Inc. that he had been spending a full fifth of his day reassuring investors. “I don’t know that I had a full appreciation for how much time I’d spend on external communication,” he said at the time. That requires a lot of discipline and patience, when many founders would rather be focused on growing the business.
Michael Dell, who two years ago took his namesake company private after 25 years on the public markets, says dealing with investor relations took up 20 percent of his time as well. “And it was the most annoying 20 percent,” he says. Those annoyances are compounded by the fact that there’s a broad range of investors, analysts, and journalists scrutinizing your company. Staying private won’t protect you from all of this attention, of course–consider Uber or Airbnb–but it does better restrict the amount of information available to outsiders.
Jacqueline Kelley, Americas IPO markets leader for Ernst & Young, which works with companies on all aspects of IPO preparedness, advises soon-to-be-public CEOs to start practicing for the increased scrutiny as much as two years beforehand. “That includes holding mock earnings calls with your private investors,” she says. “We’ve been studying top-performing IPOs for 30 years, and one of the constants is that private company CEOs who prepare and act as public CEOs beforehand perform better later.”
Those first few earnings calls can be especially tough to navigate, because you have to determine how much information is too much–or too little–for your different audiences. “You’ve got new investors you have to educate,” Alpha IR’s Hodges says. “You also have reporters listening, and you have to balance what investors need to know with not giving more information than you want your competitors to know.”
But you also have to reveal enough to make investors understand what makes your company valuable relative to its competitors. One of the great ironies, Cavens says, is that a company’s more unorthodox practices–the kinds of things that can define a business–are often the ones that come under the most fire from shareholders. Cavens, for example, spent “at least 15 minutes in every investor conversation” discussing shipping: While most e-commerce companies compete on next-day and same-day delivery, Zulily consistently prioritized a diverse product offering over faster shipping. “I have very short hair,” says Cavens, who’s bald, “but I often feel like pulling it out, because these are just the wrong questions to be asking. Investors like to try to define you based on others.”
Lesson: Unless you’re bootstrapped, you already have to explain your business decisions to somebody. But do you want to have to explain them to everybody?
Warning No. 3
It’s Easy to Get Distracted by the Short Term
The fact is, if you want to become a public-company CEO, you need to be ready to move quickly. CEOs who had been in their jobs less than three years were more than twice as likely to be forced out as those who’d been around longer, according to a 2014 study by the consulting firm Strategy&. As you’d expect, CEOs who delivered the lowest shareholder returns were forced out more often than those who generated the highest.
The pressure to move fast and focus on the stock price is deeply entrenched in corporate culture. One of the most widely accepted maxims of public companies is that the CEO has a fiduciary duty to maximize shareholder value. There’s no legal requirement to do so, but the idea has become unassailable–and because of it, activist investors are always ready to pounce. The problem, many CEOs say, is that things you might do to boost the stock price in the short term can run counter to what you’d do to build the business for the future–by sapping money for R&D and sometimes by emphasizing contradictory goals.
Michael Dell calls the pressure to manage to quarterly earnings a “90-day shot clock,” and it’s one thing he’s glad to be rid of now that his company is private again. About nine years ago, Dell’s PC supremacy began to wane, and the company began a long process of building new business lines around enterprise IT solutions, which has required the kind of large investments that don’t pay off in the short term. “We can move better and faster as a private company,” Dell says. “We can focus less on short-term results and more on mid- and long-term growth.”
A recent study by Wharton professor David Hsu and Vikas Aggarwal of international business school Insead backs Dell up; the researchers found that going public can dampen innovation and reduce a company’s appetite for risk, and that the reason for this is increased emphasis on short-term results and public disclosures.
“My biggest worry before going public was that we would lose who we were and fall into a quarterly trap,” Zulily’s Cavens says. “We said we would go down this path but vowed to keep our focus on doing the things we would do as a private company, even if that means a bump or two.”
As difficult as persuading Wall Street to accept that kind of balance (see HomeAway’s marketing investment snafu) is getting managers and employees to keep perspective–especially when they own stock. Market fluctuations affect their perceptions of both their own net worth and how they’re doing at work.
On the day of Zulily’s IPO, Cavens sent a note to his staff warning them not to let the stock price drive their emotional engagement. “When the stock price goes up any given day, we are just not that much smarter,” he wrote. “And similarly, when it goes down any given day, we are not that much dumber.”
The message, which Cavens reiterated every quarter, worked at first–but in recent months, as the stock slumped, Zulily struggled with internal employee reassurance and external recruiting. Like those of GoPro, Zulily shares soared to extraordinary highs in the company’s first few public months, from a IPO price of $22 to more than $72–and then fell back down to below its IPO price. Two consecutive bad quarters then sent the price down to the low teens. Liberty’s buyout offer, $18.75 a share, valued Zulily at less than its IPO price.
Entrepreneurs should be prepared to take six back-to-back meetings with investors on a daily basis during an IPO road show, which typically lasts two weeks. “A lot of entrepreneurs are surprised at the extensiveness of the IPO road show,” says Robin Feiner, senior counsel at law firm Proskauer Rose.
14: Number of consecutive years of relatively low IPO volume. As existing public companies fail or sell out, and fewer new companies go public–choosing to find larger buyers instead–“there’s been a pretty substantial decline in the number of publicly traded companies, especially smaller companies,” says the University of Florida’s Ritter.
As the stock slid over the past several months, Cavens found that his recruiters were having a harder time selling the company to job candidates. After the sale was announced, he would not directly discuss whether the IPO had been the right choice for Zulily, aside from acknowledging “benefits and challenges” both before and after. But he singled out the impact of short-term stock movements as a particular post-IPO challenge.
“Being public gives investors and employees liquidity on their equity,” Cavens said in August, “but also brings expenses and a daily stock price that some people get overly attached to.”
Making decisions for the long term while minding the short term is, to some extent, a learnable skill, a balancing act that requires muscles that get stronger over time.
“As a public CEO, you find yourself having two voices in your head, always,” Sharples says. “When people bring me big ideas, I always think, ‘Is that better for our customers or not?’ And then I think, ‘How will that play to Wall Street?’ Where it gets hard is when you know in your heart it’s good for the business, and you also know it won’t play for Wall Street. It takes guts to get in there and do it.”
Lesson: While you always have to balance your company’s short-term and long-term objectives, going public will increase the pressure on the former–and require more discipline to maintain the latter.
Warning No. 4
The IPO Is Not the Finish Line
“I build things and get to watch customers buy and use them–that’s tremendously satisfying,” says MailChimp co-founder Chestnut. “Sometimes I see companies build things I know are for investors–and what is the investor’s purpose? Just to increase wealth. That doesn’t align with my mission.”
For him, even just considering investors ahead of customers goes against the whole reason he started a business. As a result, MailChimp has stayed private for 14 years. The email marketing service, which has eight million users and has been profitable from day one, was entirely bootstrapped–a rarity among leading tech companies. Even after competitor Constant Contact went public, Chestnut responded not by raising a ton of money but by getting scrappy. “We said, ‘How can we make our product better than theirs?’ We came up with a freemium business model, and we doubled our users overnight.”
Ken Grossman, the founder of the craft brewer Sierra Nevada, tells a similar story. He wrestled with the possibility of going public in the ’90s, when many other fast-growing independent brewers were doing so and his founding partner wanted to cash out. “I felt that the fiduciary responsibilities to look out for shareholders would constrain some of the things I wanted to do that might not provide the greatest short-term gain,” like doubling down on quality equipment or investing in green energy, he says. “The irony is that if I leveraged the company and went public, it would be easier to get the resources I needed, but then I’d have had different masters with different requirements.”
After weighing private investors and deciding they’d bring him some of the same woes as the public markets, Grossman managed to buy out his partner with bank financing instead. He funded some key upgrades in the same deal, and several years later he owned 100 percent of his company. In 2012, he took on debt again to open a second brewery, and managed favorable terms, in part because the craft-beer industry is hotter than ever.
Neither Grossman nor Chestnut believes his company would be what it is today had it become publicly traded. And yet, many public-company CEOs can’t imagine having done it any other way–and say they’d do it all again.
Cotter Cunningham, a veteran public-company executive who founded the online coupon aggregator RetailMeNot in 2009 and took it public in July 2013, has since been able to fund several acquisitions. “The flexibility from a financial standpoint seems six times that of a private company,” he says. “You can raise debt. You can buy bigger companies. You can raise cash if you need to by selling more stock.”
Jon Oringer, who founded photo database Shutterstock in 2003 and took it public nearly a decade later, even argues that sometimes it’s easier to manage public investors than private ones: “If you’re a private company, especially if you’ve done multiple funding rounds, you have investors who have been in your business different amounts of time and have different rights.” That can get complicated quickly, he says, whereas “being public, anyone can get in and out of the stock at any time. That lets us focus on where we think the business should go.”
Still, many founders admit that most post-IPO satisfaction comes only after a long slog, a steep journey with a lot of pitfalls to go with the rewards. “There’s a tendency among entrepreneurs in private companies to see an IPO on the horizon as kind of an endpoint,” Cavens said months before he decided to change Zulily’s trajectory. “They shoot for it for years, and it’s only natural to feel like you can cross that line and then collapse. The reality is more like you just ran a 5K, and as soon as you’ve crossed the finish line they tell you it was just the warm-up for a 100-mile ultramarathon. And it starts now.”
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