Short Circuit is a quarterly newsletter intended as an antidote to the onslaught of information that characterises both technology and financial markets. Inspired in part by Alvin Toffler’s 1970 book Future Shock, I hope to use some of the latest news, events and developments as a jumping off point for discussing a broad range of issues that will be vaguely technological and future related. It is designed to be thoughtful but relaxed; as a comfort blanket against the barrage of the outside world; like your first cup of tea in the morning.
We are hastening towards the third anniversary of the christening of Tech City in London. It is perhaps inevitable that, given the hub has received direct government funding, the question of its value is often debated. No doubt a successful IPO from a firm grown out of Tech City would help its supporters immensely; a poster child for the success of a venture that is sometimes hard to even define. Yet the finance world has changed. Private equity is a much greater force than it was a generation ago. What do modern public markets offer maturing companies and, in the end, do IPOs really matter anymore.
The last thirty years has seen the inexorable rise of private equity and other forms of private capital. From virtually nothing before the 1950s, private equity has come to manage $2 trillion worth of capital and grows at over $200 billion every year. This is a substantial pool of capital for business leaders to tap in itself, not to mention early stage financing such as venture capital.
There is somewhat of a natural fit between technology and private capital. Young technology companies often have disruptive ideas that require a change in thinking across the industry. This can take time and private capital, at whatever stage, can allow for that incubation. As if to demonstrate the point, the first private equity/venture capital success story was actually a tech company, Digital Equipment Corporation (DEC), back in 1968. DEC took eleven years to reach IPO from its first $70,000 investment.
With a smaller number of investors to deal with, it allows management to be much closer to the investors. This allows for a shared partnership with a common goal to develop, enhancing that nurturing advantage.
There are more general advantages too. There are many more distractions for public firms, whether it be watching (and sometimes managing) the share price in real time, reporting to the market on a quarterly basis or dealing with a multitude of (ultimately insignificant but nonetheless self-important!) investors across the globe. There are numerous instances over the years of businesses getting into trouble because they focused too much on near term expectations and the movements of the share price at the expense of long term success.
And finally, of course, with private capital founders often get to retain overall control of the company.
Given all of this, it begs the question of whether IPOs, and the stock markets themselves, serve a fit purpose for today’s successful tech entrepreneurs.Let’s take the example of Google. They raised $1.67 billion at IPO in 2004. Yet they have never had less than $2 billion in the bank since (in other words they never needed the proceeds). Larry and Sergey have retained 65% of the voting rights in Google and have shown a general hostility towards the market from the start. Neither the founders, nor Eric Schmidt, even meet directly with (fellow) investors. You wonder why they bothered at all.
More recently we have seen Twitter go public with a $2 billion IPO and their registration document lists the principal purposes of the offering to “increase our financial flexibility, [and] create a public market for our common stock.” It suggests the benefits of a public listing are self evident. So what is the advantage of moving to an IPO?
For all its growth, though, private equity still cannot compete with public markets for size. That $2 trillion compares to a combined $29 trillion across New York, London, Frankfurt, Paris and Hong Kong. The $12 billion that Facebook raised in 2012 would have represented one of the largest private equity deals ever done, yet the NASDAQ exchange in New York barely skipped a beat.
The public markets also demand the highest levels of standards and scrutiny, which can be important for building trust.
In the end however, the IPO will remain because it offers one killer feature: the ultimate exit.
All investors must periodically decide where they want to place their efforts and their capital. Without the prospect of an IPO, a lifelong marriage is probably more than most investors wish to sign up for and in a large number of cases it would probably prevent them doing so in the first place. This could apply just as readily to other large stakeholders like founders and early employees.
On the other hand, once public, the stock markets allow every to decide his or her exit on a real time basis. For all the noise and volatility that the daily gyrations generate, and for all it sometimes looks like one big casino, that ‘liquidity’ retains a high intangible value. That is why they matter and why they remain an important final step from start up to multi-billion pound success story.
As for Tech City, IPOs are an inevitable bedfellow of success. Nevertheless, it is important to remember DEC. For a company, or indeed a hub, starting from scratch these things take time.
A version of this article first appeared in Issue 1 of Tech City News (print edition). Chris Woodcock is an independent technology analyst. Get in touch: chris [at] cedillaresearch [dot] com / @chrisjwoodcock