Investors & Funding
9 minute read

Looking at Failed IPOs in the Age of the Unicorn

Natasha transitioned to venture capital after a career in banking built in prestigious firms such as JPMorgan and the ESM.

For many years, the initial public offering (IPO) market appeared completely dormant. It had never recovered from the high-profile flops of the dot com bubble, in which many seasoned and less seasoned investors lost substantial amounts of money. The financial crash most definitely did not help the renaissance of the sector, as did the increase in private markets and the rise of the super fund.

Number of IPOs in the United States from 1999 to 2018

Number of IPOs in the United States from 1999 to 2018

2019, however, appears to be bucking the trend, with a large number of high-profile tech companies going live on stock exchanges. Beyond Meat, Uber, Lyft, and Pinterest are all examples of high-profile companies that have gone public this year, with Airbnb and The We Company (the parent company of WeWork) slated for their stock market debut at some point this year.

Not all of these IPOs have been successes: Take for instance the different fates of Beyond Meat and Uber. Beyond Meat (NASDAQ: BYND), which we recently discussed in another article, is being reported on as one of the biggest successes of recent years, not just 2019: In fact, its IPO was the best performing one for a company listing for over $200 million since the financial crisis of 2008. As Howard Lindzon wrote on the 29th of July, “The best performing asset of 2019 is Beyond Meat—at $14 billion, it has a larger market cap that 30 percent of all S&P Companies—and which Ivanhoff calls a biotech edible.” (Note: This was written before Beyond Meat announced its unexpected follow-on offering and took a significant dip; however, the stock is still up by approximately 170% since its IPO). Uber Technologies (NYSE: UBER), on the other hand, has been covered by an endless amount of articles as being a flop, a failed IPO. The company raised over $8.1 billion, but failed to achieve its desired valuation target of $100 billion; the stock dropped sharply on the first day of trading, making it one of the worst IPOs over $1 billion.

US IPOs Over $1 Billion, Worst Performers

US IPOs Over $1 Billion, Worst Performers

Even as the stock recovered, it is still languishing right below the IPO price of $45.

Uber Stock Price Since IPO

Uber Stock Price Since IPO

And it hasn’t been just tech companies that have had mixed successes and failed IPOs when coming to private markets: Anheuser Busch INBEV NV had to famously scrap its planned IPO in APAC, resorting instead to a private business sale. Finally, the latest failed IPO to make the news is that of the Chinese sports company Wanda Sports, owner of Ironman, which made its Nasdaq debut on the 26th of July. Wanda raised less than half than its desired amount, and tanked in post-IPO trading, making it the second-worst performing IPO of the year.

Finally, it is also worth spending a few words on the alternative strategy used by Slack. Slack employed the same strategy as Spotify and used a direct listing rather than an IPO. In practice, this means that it bypassed investment banks and the IPO profits while at the same time being able to enjoy the benefits of being a publicly listed company. We will cover these in more detail in the following section.

This article will provide a framework to analyze these financial events, first briefly covering the process behind the decision to go public before proceeding to cover the process and success factors behind IPOs as well as the current market and considerations for the most recent and upcoming public market offerings.

To IPO or Not to IPO?

Very few events are as momentous in the life of a company as going public through an IPO. An initial public offering describes the process through which a company goes from being entirely privately held to being traded on a stock exchange. Being publicly listed comes with many advantages, but it is also complex and costly. Overall, fewer companies are choosing to do so, and they tend to do so at a later stage. So why would a company undergo such a lengthy and complex process?

The main objectives of an IPO are to raise capital and to provide liquidity to the existing investors, which at this stage will mostly be the founders, employees, and management, and early investors such as angel, venture capital, and private equity funds. Beyond these objectives, an IPO comes with many other benefits and obligations. Among the benefits are a reputational boost, an expansion in the investor base, and a transparent valuation (liquidity). On the contrary, the obligations include an increased scrutiny from market participants and new investors as well as an increased regulatory burden.

Next is an overview of the process.

IPO Process and Execution

The IPO process usually lasts well over a year and begins with an internal assessment of the company’s readiness of its management and corporate governance structure as well as a broad assessment of the potential interest of investors in a stock of this type.

IPO Process

IPO Process

The IPO execution itself is also extremely complex. First, it requires the firm to select one or more underwriters (the investment banks that will handle the pricing and selling of the newly listed shares). Next, comes regulatory filing and due diligence processes to ensure its regulatory compliance, after which the SEC approves the IPO. A pricing and price-discovery process follows, where investors are approached to establish at what conditions and price they would be interested in the new shares. Finally, the initial period of trading begins, during which stabilization methods are used to ensure that a market for the new shares begins to exist, and finally, after 25 days, a transition to regular market trading.

IPO Execution

IPO Execution

Once the company’s shares become publicly traded, its regulatory obligations increase significantly. This burden has significantly increased since the dot com bust of the 90s, as a direct consequence of corporate scandals such as Enron and WorldCom, which pushed the regulator in the US to introduce the Sarbanes-Oxley Act (SOX). Publicly owned companies are obligated to disclose very detailed financials twice a year, as well as have key corporate governance structures in place. For this reason, any company considering an IPO would necessarily need to hire legal and compliance staff well versed in SEC requirements. On the other hand, this does give an additional level of credibility to the company, as it withstands higher scrutiny levels.

So what does this mean in practice for a growing business and for the number of IPOs? IPOs are expensive and complex: in a PWC study, the cost of an IPO was estimated to be between 4-7% of the capital raised and an additional $4.2 million of directly attributable costs. In addition, polled CFOs estimated the running costs of maintaining a public listing to be around $1 million. Many scholars have imputed these costs as a main driver of the observed trend of companies either forgoing listing entirely, or listing at a later stage of their corporate lifecycle.

Number of Public Companies in the US

Number of Public Companies in the US

What Alternatives Are There to an IPO?

Traditionally, an IPO was the preferred method for early-stage investors to “exit” from their portfolio companies. An IPO was seen as the necessary step for a company to reach its full corporate maturity, and thus change its investor base from more speculative, specialized investment firms to more traditional investors, such as mutual or long-only funds as well as retail investors. Over time, as the amount of capital available in private markets has increased substantially, many companies have chosen to use this route to fund themselves, often raising more money this way than through their eventual IPO. Uber is a good example: Uber has raised a total of $24.7 billion over 22 rounds, only $8.1 billion of which was through public markets.

Size of Private Markets vs. Public Markets

Size of Private Markets vs. Public Markets

This does not, however, mean that retail investors are now unable to gain exposure to VC-backed tech companies upon the exit of the venture capital investors: As this graph below shows, a more common exit route has been the sale of a business to another (often public) company. Investors can thus invest indirectly: For instance, buying shares in Facebook would give exposure to both Whatsapp and Instagram.

Venture Capital Exits through IPO or Merger

Venture Capital Exits through IPO or Merger

Ultimately, managers should be aware of the implications and benefits of doing an IPO and should weigh several questions before deciding whether to go through with one.

Defining the Success of an IPO

Now that the process, the implications, and the alternatives to an IPO have been explored, it’s time to review what makes an IPO a success and when one is considered a failed IPO.

At times, companies are forced to cancel the IPO altogether, as has been the case in the example covered above of AB Inbev in Hong Kong in July 2019. The main cause of such a drastic action is often a miscalculation of investor demand, leading to the decision that it is better to halt the exercise rather than to risk the failure of the operation.

The examples of BYND and UBER will be used to illustrate how the success of an IPO can be assessed.

  • Capital raised: Unless a company does a direct listing, the main goal of an IPO is raising capital. In Uber’s case, their stated goal was to raise $10 billion, which was not met. Beyond Meat, on the other hand, successfully raised at the top of their guidance range of $23-25 (which they had already revised upwards) and thus exceeded their initial goals.
  • Share price appreciation/return: This is arguably the most watched metric. Investors use share price evolution as an easy gauge of the sentiment around a stock. Uber, again, as shown in the stock price graph above, sharply declined in the first days of trading, and then languished around the offer price of $45. Beyond Meat, on the other hand, has seen its stock soar since the IPO (even withstanding its follow-on offering blip, its stock price is up ~170%).
  • Valuation: If demand for a stock is very high, valuation multiples will be high both in absolute terms and in relation to its competitors. Beyond Meat is trading at much higher multiples than other companies in the packaged food sector. Uber, on the other hand, as mentioned above, did not meet its valuation targets for the IPO.
  • Customer and employee confidence: Going public successfully is a great validation of public perceptions of a company’s management and strategy. This builds confidence and awareness of both prospective and existing customers and employees. It also allows companies to design compensation packages for management that are linked to stock market performance. It is too early to say what the impact from the IPO on customers and employees will be for Uber and Beyond Meat.

What Are the Implications?

Ultimately, the success of an IPO is determined by:

  1. Market appetite and conditions in general—the so-called “IPO window”—a Wall Street lingo term to indicate that the market is ebullient and that investors are receptive to new companies going live in public markets.
  2. The equity story: effectively a coherent narrative for potential investors.

Much has been written about the length of this window for tech companies. In particular, this has been named the IPO window of the unicorns: When very valuable privately-owned companies are finally going into public hands, after staying private for longer due to the factors covered above, i.e., the regulatory burden of listing and the large availability of alternative sources of capital in the private market. According to the Economist, beyond the appetite for tech stocks, the desire of VC funds from the 2010 vintage to start liquidating as they near the end of their life is also a contributing factor. In fact, barring a sharp downturn in the economy and a correction in the stock market (which many are, in fact, anticipating), we can expect more of these unicorns to come to markets, as The We Company and Airbnb are already set to do.

Finally, but most importantly, how compelling is the value proposition of your stock, and thus your equity story? How defensible is your business? Is management able to clearly articulate this? And is your equity story one that ties in neatly with secular trends? Perhaps this was the single reason for the outsized success of Beyond Meat: The shift towards plant-based and health and environment-conscious eating is impossible to deny. Uber, on the contrary, has suffered from the competition from the recent IPO of its rival Lyft, as well as a business many see as lacking a sufficient “moat.”

Looking at the big IPOs coming up, it appears that a coherent and appealing story is easier to craft for a company like Airbnb than for The We Company. Observing the markets’ reactions at their debut and any other potential failed IPOs is nonetheless certain to be fascinating.

Understanding the basics

What makes an IPO successful?

The goal of an IPO is raising capital. Other success measures are (1) share appreciation: the most watched metric, (2) valuation: If demand for a stock is high, valuation multiples will be too, and (3) customer and employee confidence: Going public is a validation of a company’s management and strategy.

What are the advantages of going public?

The main objectives of an IPO are to raise capital and provide liquidity to the existing investors. It has benefits and obligations. Among the benefits are a reputational boost, an expansion in the investor base, and a transparent valuation. The obligations include an increased scrutiny and regulatory burden.

How long is the IPO process?

The IPO process usually lasts well over a year and begins with an internal assessment of the company’s readiness, of its management and corporate governance structure as well as a broad assessment of the potential interest of investors in a stock of this type.