Last Friday, I had the opportunity to attend LindzonPalooza – a networking event that Howard Lindzon hosts once a year. At such networking events I like to listen a lot more than I talk and to ask as many “stupid” questions as I can. One of the more interesting brief conversations I had was with Gavin Uhma, who is one of GoInstant’s co-founders. GoInstant is a leader in web cobrowsing and it was acquired by Salesforce in July 2012 for $70M.
Me: Do you see yourself starting a new company in a few years and would you prefer to finance it yourself instead of taking outside money?
Paraphrasing Gavin – Even if I was able to finance it myself, I would still take outside money from selected sources. You get a lot more than just money when you work with the right investors. The insightful advice and connections you could receive are just as valuable, if nor more.
Then the whole conversation went into discussing the role of money in funding.
If you are a publicly traded company, you will sell your shares to the ones who pay the highest price and your bonds to the ones willing get the lowest interest rate. When it comes to funding startups, money is not a commodity and depending on its source, it comes with a lot of strings attached, not only in terms of advising as Gavin mentioned, but also in terms of exit strategies, which is a theme of a whole different conversation.
Where am I going with my rant? You have probably all heard of the JOBS act, which main purpose is not actually to create jobs, but to:
1) reduce the paperwork needed to become public, but in the same time allow companies to remain private longer
2) allow non-accredited investors to put money in the early stages of private companies
It is admirable that the JOBS Act will potentially give the opportunity to non-accredited investors to participate in the early growth stages of companies they love and which services and products they use. It could actually make many people better investors. The beauty of angel investing is that you are forced to be a long-term thinker and investor. You don’t have the comfort of liquidity. Once you are in, you are stuck for good. Long-term investors invest in people for one simple reason – regulatory and competitive environment could change, but people’s ability to adopt and seek success could remain a constant, if you bet on the right people.
The question is, if money is not a commodity in startups funding, will non-accredited investors actually benefit and have access to the “best” deals. Proper education and transparency could partially solve that problem and Angellist has been a pioneer there, but I can’t help but think that reflexivity plays a huge role in startups’ fortune. Funding is not just about enough money to keep the lights on and scale. Money always comes with some strings attached. In the case of experienced and well-connected angel investors and venture capitalists, it comes with valuable advice and a network that plays an important role in startups’ potential and success rate.
What really bothers me more as a public investor is the part about private companies being able to stay private longer and potentially go public at much higher valuations and a lot later in their growth cycle. I look at people like Howard Lindzon, who is extremely smart and he is spending so much more time, attention, efforts and capital on private markets. Does that mean that public markets are not what they used to be and don’t offer the same opportunities they once did?
Here is an old post (2011) by William Quigley, where he explains how the investing equation might have changed:
Let’s also keep in mind that public companies are generally a lot less risky than private ones. Less work and lower risk. That is how it used to be for public shareholders, but that era has ended for good. Let me give you some perspective on how much things have changed since the last tech cycle…
The investors who bought Microsoft shares at its IPO and held onto it for the same amount of time it was a private company – 11 years – were treated to several hundred billion dollars of capital appreciation, not the $650 million that Bill Gates, Paul Allen and the other early employees earned for their 11 years of grueling start-up work. Compare the Microsoft, Cisco, Amazon or eBay examples to what we see in the post-Google era.
VMWare went public in 2006 at a $12 billion valuation. It quickly rose to a $30 billion market capitalization. Thus, the existing investors (parent company EMC in this case) captured over one third of the company’s likely terminal value. Google’s founders, pre-IPO employees and early investors also did quite well, capturing a respectable 25% of the companies likely terminal value. And what of those earlier tech giants – Microsoft, Cisco, Amazon and eBay? The founders and early investors of these extraordinary businesses captured less than 1% of the terminal values of their businesses while they were still private.
The valuations of today’s private tech leaders – Facebook, Zynga, Groupon and possibly Twitter – are such that I believe upwards of 50-75% of the terminal values of these companies will be captured by the folks who did the real work and took the real risks, those who quit their jobs and begged, borrowed and cajoled friends, families and angel investors to take a chance on their far-fetched idea.
Here is the important, and game-changing, point: in order to participate in the great wealth creation taking place in this and future technology cycles, you will have to be a founder, an early employee or a private investor. The so-called easy money will be earned before a company goes public. This is a radical shift from earlier technology cycles.
A couple years later, we can see that Quigley was right when it comes to the aforementioned popular tech companies. Facebook, Zynga, Groupon have been disappointments after their IPOs. The majority of value was created for founders, private investors and employees. Maybe it is too early to judge those companies? Maybe, we should wait 10 years, before we make any drastic conclusions?
The more important question. Now that there is so much money, allocated to private investments and so many of the companies go public a lot later in their growth stage and at higher valuations, are we screwed as public investors or there is a way we could still make a decent amount of money? There is always a way.
There are just as many examples of recent IPOs, which have been extremely profitable for public investors as there are examples of IPOs that have been tragic.
Lululemon ($LULU) went public in the summer of 2007, when the market was crazy volatile, but near all-time highs. It was a $2 Billion company on its IPO day. It is a $10 Billion dollar company today.
Rackspace ($RAX) went public at some of the worst possible time – the summer of 2008, when most most people hated stocks and wanted out at any price. The rule of thumb says to ignore companies that go public during financial crises, because raising money in crappy maarkets is usually a sign of desperation. $RAX was about $1 Billion dollar company on its IPO day. Today, its market cap is about $6.5B. It was $10B only a few months ago.
Vips Holdings ($VIPS) was one of the only two Chinese companies to get listed on U.S. markets in 2012. It opened as a $200M company in March last year. Its current market cap is $1.4 Billion.
Many of the best performing IPOs of the past 5-6 years had an element of surprise in them. They either came from sectors that everyone hated or they went public when people were hating equities in general – in both cases, nobody expected them to perform well, which probably means that their valuations weren’t too elevated. There was one more very important ingredient they all shared – they spent a lot of time on the all-time high list.