09.04.17

Special Edition: Exit Triggers: How do you successfully exit (or not!) via an IPO for an early stage company

Karl R. LaPan, President and CEO of The NIIC

Sitting in an angel investor presentation last week, an entrepreneur, when asked, what the exit plan was, was quick to say when “Our company achieves $30 million in sales, we will either sell to a strategic buyer or IPO.” Since the presentation, I have been reflecting on this certain and specific statement, and whether I can take it to the bank or not. Most entrepreneurial founders pay lip service to the exit, and that is why at last year’s ACA event, it was recommended that angel investors sitting on a startup board make it part of every board meeting to discuss what an exit might look like.

As you think about IPO, you might be tempted to think about the IPO debacle and fleecing called SNAP. Why was it a colossal failure? Snap…

  • Lacked a business model;
  • Lacked diverse revenue streams;
  • Was horribly unprofitable and burning cash; and
  • Had significant and daunting competition, and its IPO built in a set of unrealistic growth prospects for user adoption.

The result: Snapchat went public at $17/share but opened at $24/share, reached a high of $29.44/share and has now settled in on $14.27/share. With a 2016 negative free cash flow of $677 million, slower growth rate of new users due to big and significant competition from Facebook and Instagram, Snap lost billions of market capitalization and its credibility in a blink of an eye.

As I think about IPOs, here is what I have discovered and learned:

  • There were only 98 US IPOs in 2016 – down from 152 in 2015 and down from a 12 year average of 138 IPOs a year. So, for a company to IPO, it must be something special. There are nearly 29 million small businesses in the US and over 500,000 new startups a year. Very few ever make it to IPO stardom and quite frankly, very few should!
  • Median revenues of IPO companies in 2016 were $66.5 million – up 76% from a year prior (and the five year average was closer to $93 million in annual revenues). 36% of all IPOs were profitable at inception up from 30% the year prior. Fewer than 10% of life sciences IPOs were profitable at inception and oddly enough, median revenues of a life sciences company IPO were $2.3 million. Of the 2016 IPOs, 45% below $50 million and 20% were above $500 million in revenues.
  • The Harvard 2017 IPO Report clearly identified some special characteristics/triggers of successful IPOs. These characteristics included:
  1. Seasoned, capable and proven management team;
  2. Buffet ‘moats’ that provide differentiation, competitive advantage and uniqueness to the company. Buffet described this notion in Berkshire’s 2000 annual meeting:

So we think in terms of that moat and the ability to keep its width and its impossibility of being crossed as the primary criterion of a great business. And we tell our managers we want the moat widened every year. That doesn’t necessarily mean the profit will be more this year than it was last year because it won’t be sometimes. However, if the moat is widened every year, the business will do very well. When we see a moat that’s tenuous in any way — it’s just too risky. We don’t know how to evaluate that. And, therefore, we leave it alone. We think that all of our businesses — or virtually all of our businesses — have pretty darned good moats.”

3. A diverse product portfolio with strong revenue growth, momentum and traction (attractive product mix and platform); and

4. Attractive product margins, strong company profitability trends and compelling industry growth dynamics.

5. In order to facilitate development of trading liquidity, the company’s potential market capitalization should be at least $200 million to $250 million.

A recent Indiana-based health care company filed an original IPO of $75 Million last year and reduced it to $57.5 Million in 2017. Despite strong sales growth over the last few years, the company lost nearly $24 Million over the last three years. While it scores high on the management team, product portfolio and revenue growth, the margins and profitability leaves a lot to be desired and the shear company size of $30 million in revenue leaves it vulnerable as it goes public so what should early stage, growing ventures think about before heading down this road.

For early stage companies, they should keep in mind:

  • It is unlikely you will go Public unless your company and business model are something really special, and if you say you will go Public you better have some compelling reasons why you are special.
  • If you take outside money, you have a boss. Your boss wants his/her return some day so make “exit triggers” a meaningful part of your board conversations. Don’t be arbitrary or politically correct by making up an “exit” number.
  • Pay attention to the characteristics/triggers that make a company a real candidate for IPO (think through the Harvard criteria and build a compelling vision, business model and plan around it).
  • Shawn Tully, a writer for Fortune, opined in the aftermath of Snapchat when he said, “The sole victor in the IPO of Snapchat was Wall Street and Wall Streeters may not be as great as they claim at trading, but they’re the greatest at persuasion—specifically, persuading brainiac entrepreneurs that doing the wrong thing is right.” Be careful not to do the wrong thing because you have been seduced.
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