Why Startup Companies are Staying Private?

Once upon a time, a successful IPO was considered to be a transition point for a startup company to be recognized as a full-fledged public company. The goal of every startup company was to finally go public on a reputed stock exchange. The only startup companies which did not want to go public were the ones that would not be able to obtain a good valuation if they went public. It was quite uncommon for companies to stay private by choice. However, all this has changed rapidly in recent years. There are many startup companies, particularly in the technology domain which are deliberately choosing to stay private.

In this article, we will have a closer look at this phenomenon as well as the motivations which are driving this phenomenon.

Startups Choose to Stay Private

Empirical data related to startups going public has been studied by many investors. The findings from this data have been astounding, to say the least. It has been found that prior to 1999, the average company would stay private only for four years before finally getting listed. However, this has more than doubled to ten years after 1999. A lot of the companies, particularly from the software domain, want to stay private.

The reason behind this choice could be the fact that high valuations are now accorded to startup firms during private funding itself. Research indicates that almost 40% of the startups which have gone public in the past 5 years have had to list at a lower valuation as compared to their last private valuation. For instance, if the firm was valued at $100 in the last private round, it had to be publically listed at $95! In some cases, even after taking a down round, the shares of the company still witnessed a tremendous fall after listing.

Now, a down round does not affect all investors equally. The founders, seed investors as well as employees who were associated with the company early on do not take a haircut since the value of their investments has grown significantly. On the other hand, late-stage investors have acquired shares at a significant premium and hence they object to a down round.

In many cases, late-stage investors have to be given a higher valuation preference in order to get them on board with the idea of going public. It also needs to be noted that a reduced valuation does not mean much to the investors unless they decide to sell at that price. Many late-stage investors are fine with listing at a lower valuation since they believe that such a listing would only cause a minor downward revision in prices.

Hence, in a way, it can be said that startups are choosing to stay private because the frenzy in the private markets leads to overcapitalization of startups finally causing them to stay private for longer.

However, this is not the only reason why companies choose to stay private for longer. There are some other reasons as well which have been mentioned below.

Other Common Reasons for Startups to Stay Private

  • A lot of new-age startups are focused on capturing market share in the early years. They tend to have a futuristic business model which does not generate cash flow for many years. Instead, they tend to have a high cash burn rate and focus on capturing market share. Now, the problem with going public is that the retail investor does not have a long-term vision. They tend to be fixated on the quarterly profit. If the quarterly profit does not go up or if the cash burn rate is higher, then the stock prices of the company begin to see a downward trend. Hence, if the company goes public, it faces external pressure and is not able to focus on its goals.

  • Many startup companies are quite secretive about their growth plans. They believe that the manner in which they plan to approach the market is competitive information that must not be revealed to the general public. However, if a company goes public, it has to publish detailed reports about its future plans. It also has to answer investor questions in investor forums. All this leads to the company divulging information that they would want to keep private. Many companies avoid going public in order to maintain this secrecy.

  • Once a company goes public, its shares will be listed on the exchange and can be purchased by anyone. This opens the company to a possibility that a hostile party might purchase a significant portion of the shares and may end up impeding the day-to-day functioning of the firm. Hence, companies decide to stay private in order to avoid hostile takeovers and hostile stakeholders

  • Also, when companies go public, a lot of their management’s time is spent in shareholder-facing activities. This can negatively affect the day-to-day operations of the firm. A startup requires its key personnel to be completely focused on building the operation instead of focusing heavily on governance activities.

The bottom line is that some companies decide to stay private because they cannot justify their higher valuation to the stock markets. On the other hand, some other companies decide to stay private since they are reaping some of the benefits mentioned above. In either case, the availability of organized private capital means that privately funded unicorns are now a norm and companies can stay private for as long as they want to.

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