As an early investor in startups, one of the most exciting potential events is when a company you’ve backed decides to go public through an initial public offering (IPO). An IPO is a major milestone that can create an exit opportunity. However, IPOs also come with some complexities. In this blog, we discuss what happens when a startup you’ve invested in conducts an IPO and some of the key things to watch out for.

What Happens When a Company You’ve Invested in Conducts an IPO?

An IPO marks the first time a company’s stock is made available for public trading on a stock exchange, like NASDAQ or the New York Stock Exchange. When a privately held startup decides to go public, the process it typically takes is to engage investment banks to underwrite the offering, determine the IPO price, and facilitate the sale of shares to the public.

For investors in the startup, the IPO can present an opportunity to realize the value of their investment. With the company’s stock now available for trading on a public exchange, investors have the potential to sell their shares and liquidate their investment. Additionally, the IPO can enhance the company’s visibility and credibility, attracting a broader investor base and potentially increasing the company’s valuation.

However, the process of conducting an IPO is complex and involves various considerations for investors. It’s crucial to be aware of the potential implications and factors that can impact the value of your investment.

IPO Timeline

Going public is a long and arduous process that typically can take between 6-9 months from start to finish. And with the unfavorable IPO conditions for the past couple of years, there could be many companies who are waiting for better market conditions before undergoing an IPO. TripActions[1] and Turo[2] filed initial paperwork in 2022 and Stripe[3] even began the process in 2021. There isn’t a definite timeline to how long the entire IPO process can take, but the following are some common steps companies may take on their journey towards an IPO.

Hiring Investment Banks

One of the first steps in pursuing an IPO is hiring investment banks to underwrite the IPO and help navigate the process. The startup will then need to file extensive paperwork with regulators like the SEC, including detailed financial statements and disclosures about the business.

IPO Roadshow

This is followed by a “road show” period where the executive team markets the IPO to institutional investors across the country. If there is sufficient demand, a price range for the shares is set based on the valuation.

IPO!

Finally, on the assigned IPO date, the shares begin trading on a public stock exchange like the NYSE or Nasdaq.

Key Considerations

As an investor in a startup that is considering an IPO, there are several factors to keep in mind:

Valuation

The IPO price at which the company’s shares are offered to the public can significantly influence the value of your investment. It may be important to assess whether the IPO valuation aligns with the company’s growth prospects and market conditions.

Lock-Up Period

Following an IPO, insiders and early investors are typically subject to a lock-up period during which they are prohibited from selling their shares.  A typical lockup is 180 days, though it can range from 90 days to a year or more. The lockup can benefit the company by preventing an immediate flood of shares hitting the market after the IPO. But it also requires current shareholders to hold their investments for an extended period.

Even after the lockup expires, there may be additional requirements around trading windows or obtaining approval for any sales. Executives and large stakeholders often have more stringent requirements. So you’ll want to consult the company and review the IPO filings in detail. Understanding the duration of the lock-up period is important, as it can impact the supply and demand dynamics for the company’s stock.

Post-IPO Price Fluctuations

In the first few months after an IPO, the company’s stock price could experience a high degree of volatility as the market tries to settle on an appropriate valuation. Sometimes momentum can drive the stock to increase in the opening days, only for it to decrease soon after.

Other times, the stock may struggle initially but then increase over time as results prove out the investment thesis. This volatility can relate to the overnight transition from shares being illiquid to becoming a publicly-traded stock influenced by market sentiment.

As an investor, you’ll want to have a disciplined approach for any potential selling. Avoid falling into the hype cycle or panic selling on any short-term fluctuations. Keep an eye on the fundamentals of the underlying business versus just the stock price movements.

Stock Compensation and Dilution

Another thing to watch after an IPO is how dilutive the company’s stock compensation practices are over time. Most startups grant generous stock option packages to employees and executives. After going public, they may need to continue offering competitive pay and incentives.

This often means issuing additional shares over time, which can dilute the ownership stake of existing investors. Review the company’s future hiring plans, cash position, and share utilization to model out the potential dilution impact on your investment.

There’s also a potential difference in how founders and executives view the stock after an IPO. Pre-IPO, their incentives can be highly aligned around increasing the company’s value. But post-IPO, they may become more motivated by short-term stock price movements that can fuel their personal liquidity or drive up the value of their options and equity grants.

Advantages of Going Public

While there are complexities, IPOs have the potential to offer sizable benefits for startups and investors alike. One of the biggest advantages is access to public capital markets. After going public, the company can raise further funding by issuing more stock rather than going through venture rounds. They have the ability to raise currency for making acquisitions, and public market scrutiny can help increase transparency.

For investors, the ability to finally have a liquid market for your shares can be a milestone. Even with lockups, an IPO can provide a timeline and process for being able to monetize at least a portion of your investment. Publicly-traded shares are typically more liquid and can be sold on an exchange.

There’s also the potential for a much broader investor base. Pre-IPO, a startup may have been limited to receiving funding from accredited investors. But post-IPO, the general public can participate and help drive demand.

Challenges of Being Public

Of course, being a public company comes with significant challenges as well. Public companies face far more scrutiny, regulations, and shareholder pressures around governance, accounting, and disclosures. This increased compliance can have meaningful operating costs.

There also can be a risk of short-term pressures influencing decision-making. Public market investors often demand consistent quarterly growth, even if that means sacrificing longer-term investments. Managing both short and long-term outlooks can become a juggling act for leadership teams.

Final Thoughts

Overall, an IPO is a major event for any startup that can create new opportunities while also adding new complexities. As an investor, it gives you potential liquidity while still allowing you to hold a stake if you choose. Investors should carefully review all the specifics around lockups, future dilution, and how the company plans to operate post-IPO. With some preparation, an IPO can be an exciting event in the life cycle of one of your portfolio companies.

Want to learn more about IPOs? Check out the following MicroVentures blogs to learn more:

• Is the IPO Window Opening Back Up?
• 2024 IPO Outlook
• Navigating Exit Strategies: IPOs, M&A, and Secondary Buy-Outs
• Demystifying IPOs: A Guide to Initial Public Offerings

Are you looking to invest in startups before their IPOs? Sign up for a MicroVentures account to start investing!

 

[1] https://techcrunch.com/2022/09/29/tripactions-ipo/

[2] https://techcrunch.com/2022/01/10/peer-to-peer-car-sharing-company-turo-files-ipo-to-go-public/

[3] https://public.com/learn/stripe-ipo

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The information presented here is for general informational purposes only and is not intended to be, nor should it be construed or used as, comprehensive offering documentation for any security, investment, tax or legal advice, a recommendation, or an offer to sell, or a solicitation of an offer to buy, an interest, directly or indirectly, in any company. Investing in both early-stage and later-stage companies carries a high degree of risk. A loss of an investor’s entire investment is possible, and no profit may be realized. Investors should be aware that these types of investments are illiquid and should anticipate holding until an exit occurs.