In defense of the IPO, and how to improve it

https://a16z.com/2020/08/28/in-defense-of-the-ipo/

by naftaliharris • 6 years ago

74 21 6 years ago

joschmo• 6 years ago

This is a breath of fresh air in comparison to HN's typical ignorance on IPOs. I can see why it wouldn't be popular here.

A mix of the theoretical grounding of the activity with the on-the-ground realities of filling up a book and mechanics of how it happens. The IPO isn't perfect, and is in need of a software-defined overhaul, but does have clear value. We'll see if Carta's Xchange product can live up those goals.

dang• 6 years ago

Please don't sneer at others in HN comments, including putting down the rest of the community. Believe me, I understand how annoying widespread ignorance can be, but the only thing that has a chance at helping is patient explanation. Adding more poison only makes things worse.

If you know more, the thing to do is to share some of what you know, so the rest of us can learn. You've done this in previous comments, which is great.

https://news.ycombinator.com/newsguidelines.html

bjterry• 6 years ago

This article is good as long as you realize that it is a very company-centric description, as you would expect from a VC.

Criticisms of IPOs on HN fall into two buckets, first whether the companies are giving up too much equity and second whether access to IPOs is fair and serves the public interest. This article mostly addresses the former, and really only briefly touches on the latter.

actuator• 6 years ago

Interesting points they are making, it would be interesting to see how much of the IPO volume gets sold out in the first week or month to see how much of the price is being driven by just a few shares.

I looked at Zoom's IPO, the trade volume on IPO day was around 26M with closing price of 62. If for simplicity we disregard the same shares being traded(trading strategies, HFT trades). This is about $1.5 B in volume, they raised $0.36 B in IPO. So, the point that the article makes about the value being driven by just a small set of "gamblers" and not the value of the whole/majority of IPO block probably needs to be looked at with data.

Is there any way to determine the big institutional trades on a particular day to see if any of the IPO subscribers ended up selling in the first few days of listing?

fadesibert• 6 years ago

Excellent article - goes into some detail on the myth of oversubscription (well, inflation of reality)

Ericson2314• 6 years ago

Excellent breakdown with the proper theory. However

In an institutional fundraise, all buyers must get the same price

Isn't that the basic problem? Don't we have tons of auction theory on how to not sell all at the same price? presumably that auction theory also properly doesn't confused the varying unit price vs total money raised (it's integral).

teej• 6 years ago

Seems very strange to leave out any discussion of auction models for pricing, like Google and Spotify used.

gonehome3• 6 years ago

Did Spotify do this? I think only Google did and Spotify was just the first to do a direct listing.

TooSmugToFail• 6 years ago

I believe this is partly due to long term relationships aspect of the IPO process.

During roadshows, underwriters are essentially leveraging their rolodexes. These relationships constitute a significant part of the value they are bringing to the table.

If there would be a different price for each investor, some would get a better price than others, and those that got a worse price would not feel very good about it, likely deeming it unfair (there are still people behind the processes, and people can't help but experience emotions of fairness and a lack thereof).

As a result, relationships would likely suffer due to this human aspect to it, and weirdly enough, these grudges can easily get absorbed in the 'institutional memory' and linger there long after the original human protagonists have left the organisation.

A way to address this, would be to introduce rules like first-come-first served, which would imply giving up a degree of control by underwriters and the company. This, however, introduces risk for the company which, after all needs that control in order to maximise value.

It's not a simple problem to solve, but maybe there is a better solution somewhere out there...

vlovich123• 6 years ago

If they want the most accurate price (doesn’t move much from the initial IPO) a blind second price bidding strategy is useful.

If the company wants the highest price they would do an auction of successively increasing lot sizes.

However, the pool of investors for something like this is small enough that you’d be trying to fight out-of-band collusion. Similarly the underwriters don’t want you to have the highest price. They want the investors to get a price better than the stock is actually worth so that they continue to show up to deals the underwriters organize.

I too think there must be a better way but I suspect you may need some regulation and enforcement of this market to actually see it through.

satya71• 6 years ago

I've read countless articles on IPOs. This is the first time I appreciated the mechanics and economics. Excellent article.

gonehome3• 6 years ago

The counter argument in favor of direct listing: https://podcasts.apple.com/us/podcast/invest-like-the-best/i...

I’m not sure anyone is arguing SPACs are a better idea for the private company?

SPACs can offer some certainty in what may be an uncertain market, but their entire point is that the SPAC creator is selling this certainty by finding an undervalued company they can take over on the cheap. I think a SPAC is a really bad way to go public unless you’re someone like Nikola where your company is basically a fraud ripping off the SPAC, in that case probably a good way to go for the founder.

I’m still skeptical of the a16z arguments defending the IPO pop. When you have banks doing lots of transactions and founders doing only one or two the transactions will likely be skewed to benefit the banks along with a really compelling narrative of why they’re not.

The simpler answer seems more likely here, I think Matt Levine is probably more correct.

https://www.bloomberg.com/opinion/articles/2020-08-06/it-s-a...

bobbylcraig• 6 years ago

I've always been confused by DPOs. Isn't it essentially a money-grab by initial investors waiting to cash out if you don't need the capital infused by the IPO?

gonehome3• 6 years ago

It gives liquidity to employees as well as initial investors and it gives the public the ability to buy shares.

unishark• 6 years ago

Theoretically you still get the capital, assuming you can sell the stock well enough yourself. A DPO just avoids paying the million(s) to an underwriter.

dperfect3• 6 years ago

This makes sense from an investor’s perspective. My objection to IPOs is not so much financial, but more about what it does to a company’s internal culture. Having been at a company that went through an IPO, I saw how that culture shifted - almost overnight. You had employees that once cared about doing their best at their jobs to ones that focused only on how their contributions would affect the public stock performance (which can overlap, but often doesn’t). Every time the stock price took a (short-term) hit, employee morale suffered. It was as if a large LED stock ticker were installed on every desk, constantly reminding employees that this is the new key indicator that matters above all. It was obvious even among upper management; discussion went from big picture, somewhat ambitious ideas to short-term thinking, centered on how to show good numbers in the next quarter with obvious, incremental adjustments (like pushing more ads rather than developing more interesting products and features).

The funny thing is, the company didn’t actually need the funds raised in the IPO. They had an almost endless supply of interested private investors pouring in money regularly, and the company’s CEO (in private) admitted that they never wanted to do an IPO. It was only necessary in order to appease the expectations of early employees who had been promised a big payday for the shares they were offered instead of competitive salaries. I understand why that was done in the company’s early days, but there ought to be a better way to reward/incentivize early employees that doesn’t rely on the fickle and myopic nature of publicly-traded stock.

vkou2• 6 years ago

I understand why that was done in the company’s early days, but there ought to be a better way to reward/incentivize early employees that doesn’t rely on the fickle and myopic nature of publicly-traded stock.

The IPO is the carrot that you're dangling ahead of early employees many years prior to getting to that point.

When you've gotten to a state when you're ready for an IPO, they are expecting to actually get that carrot. You have no leverage or new incentives that you can give to an early employee after you IPO. If they are sticking around after, you're either drowning them in money, or they are doing it as a courtesy.

So, your alternatives are to ask them nicely, or give them a boatload more money to stick around.

They had an almost endless supply of interested private investors pouring in money regularly

It sounds like they were interested in pouring money in to grow the business, not to reward early employees. (Which is perfectly reasonable.)

This is why you're finding the two things at odds with eachother. As an employee in a pre-IPO company you have a much smaller small amount of leverage for any sweat equity you put in, compared to someone who paid real dollars for their equity. Your interests aren't aligned with your investors, and their interests aren't really aligned with yours, outside of one thing - you both want to get to a point where you can cash out, via IPO.

dperfect3• 6 years ago

The IPO is the carrot that you're dangling ahead of early employees many years prior to getting to that point.

Yes, that's essentially what I'm saying, but I wonder if there aren't some better alternatives to incentivize early employees when cash is scarce. Maybe (just off the top of my head) something like a contract to pay the employee a set dollar amount (with interest) at an undetermined point in the future, and it must be paid before any profits can be distributed to owners (there could be other triggers as well). This would be in addition to the employee's salary, which is likely to be at below-market levels when the company is still young.

It could come with additional features similar to a vesting schedule, but essentially it would (1) give the employee a known dollar amount of compensation contingent on the company's future success, (2) allow the company to remain private (if desired) while still delivering the "carrot", (3) avoid the need for an option pool, and (4) avoid the issues I described in my earlier comment. After some or all of that amount is paid to an employee, the difficulty in keeping the employee around is no different, but at that point (where profitability allows for the payout), a company is more likely be in a position to offer/renegotiate competitive salaries in the first place.

Then again, a lot of founders/owners probably don't want something so concrete because of course they benefit from being able to attract talented people at a discount by offering a tiny bit of equity and the dream of becoming a millionaire when the company IPOs or gets acquired. Heck, I've been there - on both sides of the conversation. But the truth is, a lot of people are realizing that equity isn't usually worth what a founder thinks it is, so that's becoming a less effective bargaining chip as time goes on.

rebase-vc• 6 years ago

the much bigger problem than pricing is timing. retail investors don't get a chance to buy in until the company is already valued at $1-$10B because institutional investors hoard all of those gains.

the other issue is VCs using public markets as a dumping grounds for shi... I mean not so great companies like blue apron or lendingclub, and leaving retail holding the bag.

software is eating the world and capitalism is eating itself. i say this as someone that has benefited from software and capitalism but also knows that the system is extremely flawed

In defense of the IPO, and how to improve it

Related Stories