The absolute beginner's guide to how and why tech companies get on the stock market - and why Uber is waiting so long
The vast majority of privately-held tech startups are funded by venture capital investments. Ride hailing company Uber leads the pack today, having scooped up a record-setting $8.81 billion from investors.
Whenever an investor puts money into a startup, they get a slice of ownership in what they hope will one day become an immensely valuable startup.
Cash-strapped startups can go back to the well to raise more money as many times as they can convince investors to pay up. For instance, genetics startup 23andMe raised $225 million in six funding "rounds."
The problem is that the later investors get into a company, the more cash they end up paying for a smaller slice of the proverbial pie.
Eventually existing investors get antsy for a return.
And so, at a certain point, there are two major options for a startup. The first is putting yourself up for sale and hoping a buyer with deep pockets comes along. When Facebook bought Instagram for $1 billion in 2013, it was twice the $500 million that the app's investors thought it was worth. That's a hefty payday for all involved.
A riskier but more prestigious option is "going public," or having your company listed on the publicly-traded stock markets. An initial public offering, or IPO, is considered a sign of confidence in the company's future. Plus, if your company performs well on the stock market, it means a huge cash influx.
Theoretically, a profitable startup that doesn't need any funding can keep going forever. But in reality, investors, founders, and early employees get anxious about cashing out. Venture Capitalist Fred Wilson recently said Uber CEO Travis Kalanick was "wimping out" by not taking the company public (Wilson is not an investor in Uber).
But going public carries its own set of risks. First off, it means exposing a lot of your financial information that you might wish to keep secret from competitors. For instance, when Box filed the paperwork to go public in 2014, we saw that it spent a lot more on sales and marketing than it was generating in revenue.
Back in the Dot-Com boom of the late nineties, lots of companies relied on non-traditional metrics to tout their business performance. That resulted in a lot of implosions, as their business models fell apart.
Going public also means that startup executives are beholden to a whole set of stringent laws on what they can and cannot say because it could be construed as manipulating the market.
A hilarious example was in 2004, when Google founders Larry Page and Sergey Brin violated the "quiet period" rule by giving Playboy magazine an interview too close to the search giant's IPO.
No, seriously, that happened.
The IPO process itself is fraught with peril. First, startups have to pay attention to the overall health of the stock market: It's not a good look if your company debuts during a time when nobody is interesting in tech stocks.
Second, you have to be careful about your IPO price. Set the price too high and nobody will buy the stock, making the company look troubled. Set it too low and the stock will pop, but secondary investors will capture all the gain and you will have left money on the table.
But assuming it all goes well, a good IPO makes everybody happy: Investors and founders can sell their shares on the open market, making a lot of money in a heartbeat. A $10 million investment can turn into a $100 million payout.
It doesn't always go so well, though. Recent high-profile tech IPOs like Square and Etsy have hit rough patches since their Wall Street debut. Etsy started at $16 per share, but closed out 2015 trading at less than $9.
When a startup's IPO fizzles, it's more than just embarrassing — it implies that maybe the company isn't worth as much as investors thought it was. That has a ripple effect back to early startups, who might find that investors aren't so interested in your pies after all.
And high-flying IPO or not, going public means a startup now has to answer to public shareholders. Which means that the startup's leadership is at risk if so-called activist investors decide that the CEO isn't doing a good job. That's what's happening to Yahoo CEO Marissa Mayer right now.
So it's not much of a surprise that Uber has been dragging its heels on an IPO: The market's not hot, and it seems to have no trouble convincing investors to keep pouring in billions. Still, the market moves in cycles, and IPOs will eventually become fashionable once more.
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