Silicon Valley Startups Lose Their IPO Luster

Some experts say the growing cost, regulatory oversight and pressure to please shareholders are fueling a longer-term trend of startups rejecting the IPO.

by Marisa Kendall, The Mercury News / May 20, 2016
Mark Zuckerberg rings the NASDAQ bell at the Facebook IPO on May 18, 2012. Facebook

(TNS) -- Initial public offerings have long been an essential piece of the Silicon Valley success story, but these days, a growing number of startups are finding IPOs about as helpful as dial-up Internet.

"If you're a great private company, why would you want to go public?" veteran venture capital investor Tim Draper asked. "You have to spend $5 million a year to comply, you have the possibility of a class-action lawsuit if your stock goes down, you have to think quarter to quarter -- you can't do any long-term thinking because you have to be thinking about the way your earnings look."

Just 17 percent of companies surveyed in a 2016 Silicon Valley Bank study said their goal was an IPO, compared with 19 percent that wanted to stay private and 56 percent that wanted to be acquired. In a Nasdaq Private Market survey of companies attending music and media festival South by Southwest in Austin this year, 42 percent said "no way" when asked if their company would go public in the future -- up from 26 percent in 2015.

The change in startup strategy comes amid a chilly IPO market. Just two non-healthcare tech companies have gone public this year amid the rocky stock market and slowing spending by VCs. But experts say the growing cost, regulatory oversight and pressure to please shareholders are fueling a longer-term trend of startups rejecting the IPO.

Federal regulations such as the Sarbanes-Oxley Act -- the government's response to the 2001 Enron scandal -- have made it more expensive and burdensome to go public, said San Francisco attorney David Goldenberg, who represents tech companies. The price tag varies depending on the deal's size and complexity, but can range from a few million to tens of millions paid to lawyers, auditors, accountants and the SEC, according to a 2015 PricewaterhouseCoopers report.

At SurveyMonkey, executives considered an IPO but so far have decided the costs outweigh the benefits, said Chief Operating Officer and Chief Financial Officer Tim Maly. The online survey platform, valued at $2 billion, may never go public.

"Sitting here today, I wouldn't say that we have to go public," Maly said. "If there continues to be strong availability of capital at the right price and terms in the private market, if we don't feel like we need the additional branding of being public, if we don't need additional acquisition currency -- then I don't think it will be something that we have to do."

While venture capitalists are tightening their belts -- VC funding has slowed after a mid-2015 spike -- many private companies continue to raise huge chunks of capital that would have been unthinkable several years ago. Uber has made a habit of raising $1 billion or more at a time, and CEO Travis Kalanick recently told CNBC he's going to make sure an Uber IPO "happens as late as possible."

Palo Alto-based senior services company Home Care Assistance also isn't operating with an IPO in mind, said CEO Lily Sarafan. She says the company, which provides in-home care to seniors in 40 states, hasn't ruled out going public. But since Home Care Assistance is turning a profit and doesn't need additional capital from an IPO, she'd just as soon not subject the company to the complications and scrutiny of the public market.

In particular, Sarafan says she would worry about the market's tendency to generalize -- a misstep from an unrelated health company could unfairly turn the market off Home Care Assistance, she said.

"There are at this time zero benefits to us considering that path," she said.

Of course some VCs are fighting this anti-public market sentiment, arguing that IPOs are a vital part of the Silicon Valley ecosystem. And there are plenty of companies that still intend on going public eventually, such as San Francisco-based Gusto, which runs an online human resources platform. An IPO provides valuable branding, said CEO and co-founder Josh Reeves, and public scrutiny isn't a bad thing if a company is proud of how it operates.

"There's nothing to be scared of," he said. "An IPO is a great validation of a business model."

As Silicon Valley companies avoid going public, they risk creating unrest among employees and investors who need an IPO to cash in their company stock. To address that issue, some companies are allowing their employees to sell a percentage of their shares on the private market.

SurveyMonkey has held several rounds of trading using the Nasdaq Private Market platform. Private Market, which acquired rival SecondMarket last year, works with companies to set up deals where the company buys back employees' shares, or sells them to mutual funds and other outside investors. Companies also can use these deals to provide returns to their venture capital backers, though it's less common.

The private trading market is only about 4 years old, but it's picked up speed quickly, said Bill Siegel, head of Nasdaq Private Market. The platform's private deal volume grew by 33 percent last year over the year before.

"The numbers continue to go up," Siegel said. "The types of transactions people are doing are getting more standardized, more routine."

But the private market isn't as well regulated as the public market, Siegel said, which has given rise to some "bad actors" who use the market to scam investors. In 2014, the SEC charged a Santa Barbara-based stock promoter with misappropriating $3.5 million investors thought he was using to buy shares of Facebook and Twitter before the companies went public.

Draper, who recently launched a $190 million fund with the intention of allowing his portfolio companies to remain private forever, says the current private market is too small to meet the liquidity needs of employees and investors. He's on the lookout for the entrepreneur who can solve this problem with a creative new platform to facilitate private trading.

Scott Kupor of Andreessen Horowitz has a different view. While private exchanges are "interesting," he said, they don't change the fact that someday employees need an IPO to obtain the full value of their stock.

It's still worth it to go public, he said. "I don't think these companies can stay private forever."

©2016 the San Jose Mercury News (San Jose, Calif.) Distributed by Tribune Content Agency, LLC.