The Anatomy Of A Successful IPO

I have been fortunate that three of the investments I led for Sapphire Ventures (Nutanix, MuleSoft and Alteryx) have had an IPO in the last six months*. These experiences have illuminated some IPO fundamentals that I hope will help your company evaluate this critical milestone.

The generally held belief is that every entrepreneur contemplates becoming a public company and ringing the bell on NYSE or Nasdaq. Going public is a great step in the evolution of the company. But before embarking on the journey to becoming a public company I believe every entrepreneur should have a clear answer when asked “why do you want to go public?”

The road to an IPO is a long one…all three of the companies mentioned above started thinking about becoming a public company at least 24 months before they went public.

An IPO helps companies in a few different ways:

1. Raising capital. A typical IPO raises between $150 to $250 million for the company although it can be significantly larger when consumer internet companies like Snap or Facebook go public. It is also easier to use publicly-traded shares to make acquisitions after an IPO.

2. Investor exit. An IPO could be an opportunity for existing shareholders (both investors and management) to take some money off the table by selling their shares at the public offering.

3. Expanding your customer base. Most large enterprises will not make multi-million dollar recurring revenue purchases from a private company. Becoming a public company with publicly-available financials is almost always a requirement to land these kinds of large deals.

4. Brand awareness. Going public (especially if it’s a large offering) is free marketing for the company. It creates awareness of the company amongst potential customers and can also help recruit top talent.

While these benefits are indeed enticing, as an entrepreneur or CEO, you should think long and hard about how being public can help the company before embarking on the IPO journey.

Public companies face added regulations and disclosure requirements that are monitored by the Securities and Exchange Commission (SEC). There are high added costs, which include the generation of financial reporting documents, audit fees, investor relation departments and accounting oversight committees to comply with these regulatory requirements.

Public companies are also faced with meeting the expectations of the market every quarter, which causes them to focus more on short-term results rather than long-term growth. Public investors don’t have a lot of patience and will sell off their holdings if the company misses expectations even a little bit. Finally, there are plenty of large private companies like SAS and ESRI, which have done quite well without becoming public.

If you do decide to embark on the journey of going public there’s no magic formula for successfully navigating the difficult and often grueling process. But there are three main things that can help smooth the road ahead:

1. Be able to tell public investors a story with your numbers

Ex-Box Director of Communications Ashley Mayer writes: “the survival of any high profile IPO ultimately comes down to your story: how well you can tell the parts of it you can control, and perhaps more importantly, how well you anticipate and prepare for the parts you can’t.”

As a startup, you’re focused on telling the story around the exciting technology you’ve built. You need to be prepared to tell that story through the mechanics of your business:

1. Repeatable business model: It’s not just enough to make upwards of $100 million in ARR. You need to have a very good idea of what you’re going to be making next quarter, and the quarter after that.

2. Burn rate: Cost-efficiency is extremely important especially for enterprise SaaS.

3. Plan for growth: A plan to drive upwards of 40 percent revenue growth at over $100+ million in revenue, and that means making sure your TAM is really really big.

If you can put together and execute a plan on a financial plan eight quarters before you plan to IPO, it gives you a lot of credibility with investors.

The public markets — especially with the enterprise — focus especially on a company’s TAM. The way you go about showing that TAM is part art and part science — it’s not just putting up some numbers on the board.

Example:

• One company I advised prior to its IPO increased their TAM by building out strategic partnerships well in advance of going public. By building out product integrations with partners, they were able to demonstrate a much larger TAM.
• When public investors ask you about your TAM, they’re trying to assess your business’ risk — severe dependencies on a platform, technology or regulatory measure all represent high risk.

2. Diversify your board

It’s crucial to plan ahead for the makeup of your board of directors. The SEC and other regulatory bodies want to make sure that your board composition is diverse, with many independent directors and audit boards. More importantly you need directors on your board who have not only gone through the journey of taking a company public but have also run and operated large public companies.

Having well-seasoned operators on your board will help smooth the journey of taking a company public and then building a large public company. However, you need to build this board of directors 18 to 24 months before the IPO because it can often take longer than you expect to find directors with relevant experience.

Remember:

• Venture investors don’t count as independent directors because they’ll be shareholders of your company post-IPO.
• Ahead of an IPO, companies need to shift from an investor-heavy board of VCs to a board that’s primarily filled with independent directors.
• Post-IPO, companies must have audit, compensation and governance committees at the board level that meet SEC and stock exchange rules.

3. Rally the troops to focus on the long-term

Going public can be a big distraction for everyone in your company, and you can’t lose sight of operating the company smoothly as you transition from a private to a public company. Be prepared to rally the troops from the ground up and focus on the following:

• Operational excellence: Public investors are far less forgiving than private investors. So make sure that every part of the company is operating smoothly, especially sales and marketing. Missing the financial guidance that you give to the street even by a fraction for the first four to six quarters as a public company can be extremely costly and cause your share price to drop significantly.
• Culture: There will be a lot of rotations in the employee base during the first 12–18 months after a company becomes public. Lots of employees who were part of the company in its early stages will leave voluntarily to go work for other startups or will have to be replaced as they cannot scale with the growth of the company. The new talent that you attract will typically be from larger established enterprises with a reduced appetite for risks. However, it is very critical that the culture of the company is maintained through this transition. The agility and nimbleness typically associated with startups should not die after the IPO with this new crop of employees.
• Long-term value creation: The stock price does not only keep moving up linearly after an IPO. There will be lots of ups and down with the stock price and it is extremely critical that you keep employees focused on long-term value creation. In the short-term, if there is a sharp drop in the stock price, it can cause low morale especially with employees who joined closer to the IPO and whose options are underwater. Find creative ways to boost morale and lock-down key employees with potentially additional stock options or RSU grants.

An IPO isn’t an end goal for a company, but a financing event to start a much longer journey as a public company. I’ve been privileged to watch multiple businesses with amazing teams undertake this journey to an IPO and successfully become large public companies. I am hoping that some of these learnings will help you on your journey to “ring the bell” at NYSE or Nasdaq and build an iconic public company.

Disclosures

The opinions expressed here represent those of the author and not necessarily the views of Sapphire Ventures.

Nothing presented herein is intended to constitute investment advice and under no circumstances should any information provided herein be used or considered as an offer to sell or a solicitation of an offer to buy an interest in any investment fund managed by Sapphire Ventures. Sapphire Ventures does not solicit or make its services available to the public and none of the funds are currently open to new investors.

The investments identified above do not necessarily represent all of the investments made or recommended by Sapphire Ventures, and were not selected based on the return on Sapphire Ventures’ investment in them. The companies listed above represent all of Sapphire Ventures’ investments, IPOs and exits in the SMB, financial services, digital media, sports technology and health technology domains since 2011. It should not be assumed that any current or future investments were or will be profitable. Past performance is not indicative of future performance.

A complete list of Sapphire Ventures’ direct investments, as well as IPOs and M&A exits (denoted by an asterisk*), across our Growth Fund and Fund Investments is as follows and can be viewed here. Aepona*, Alfesco Software, Alteryx*, Apigee*, Apriso*, Black Duck Software, Box*, Catchpoint, Celarix*, CloudHealth Technologies, Connectiva*, Control4*, Convercent, Criteo*, Currency Cloud, Cyphort, Datria*, Docusign, DSSD*, Endeca*, ExactTarget*, Feedzai, Fitbit*, Five9*, FollowAnalytics, Gild, Groundwork*, IEX, Ignite Technologies*, Imprivata*, Inkling, Integral Ad Science, Iovation, Iron.io, iTAC Software*, iYogi, Jaspersoft*, JFrog, Jibe, JustDial*, Kaltura, Krux*, Lavante*, LeanData, Linkedin*, Lithium Technologies, Livongo, Localytics, LogLogic*, Looker, Marin Software*, Mirantis, Mulesoft*, Narrative Science, Newgen Software, Next Principles*, Nutanix*, OnDeck*, One97, Onventis, OpenX, Payscale*, Ping Identity*, PubNub, Qubit, QuMu*, Recommind*, Retail Solutions, Return Path, Right Hemisphere*, Savo, ScaleIO*, Scytl, Socrata, Splashtop, Spring Mobile Solutions, Square*, Sun Basket, Tealeaf Technologies*, Ticketfly*, Tidalscale, Tremor Video*, Vendavo*, Violin Memory*, Voxeo*, and Zend Technologies*.