Getting Ready For An IPO

Last week, I attended the Bay Area IPO Summit, hosted by the Connor Group. The process of going public is a complex ecosystem involving a wide range of specialized participants. Below are my key insights from the summit, shedding light on the current dynamics of the IPO market.

IPO: A milestone in a company's journey (image credit DALL-E)

Current State 

1. Improving Market Conditions: The IPO market is showing signs of recovery. Year-to-date, 2024 has seen 30% more IPOs than the entirety of 2023. Additionally, over $300 billion in venture capital "dry powder" remains available for investment in the US.

2. Revised Definitions: Investment bankers now define "high growth" as achieving over 30% year-over-year revenue growth, while "profitability" is simply a business generating more than break-even profits.

3. Supply Constraints: Contrary to popular belief, there is no shortage of investor demand for IPOs. The real issue lies on the supply side—few high-growth companies are prepared to go public, and no further IPOs are expected in 2024.

4. Profit Expectations: For software companies, IPO investors now demand a clear path to achieving operating margins exceeding 20% within five years.

5. Revenue Benchmarks Declining: The average Annual Recurring Revenue (ARR) for companies that went public in 2022-2023 was $500 million. That figure has now dropped to $200 million, reflecting a shift in market conditions.

6. Scale ≠ Profitability: While scale is an important indicator, it does not guarantee that a company will meet the desired operating margins post-IPO.

Preparing for IPO

A number of strategies were highlighted for companies considering going public:

1. Quarterly Discipline: Begin forecasting on a quarterly basis and managing to exceed these forecasts. Establishing a "quarterly rhythm" is crucial.

2. Simplified Messaging: Define the company in a single sentence. Investors prefer clarity to plug into their valuation models.

3. Board Realignment: Venture capitalists often outlive their usefulness post-IPO. Bringing in experienced public company board members is a key step.

4. IPO Readiness: Allocate 5-6 months for preparing the company.

5. Competitive Clarity: The S1 filing must articulate competitive strengths in simple terms, comprehensible even to non-specialists.

6. Comparable Companies: Choosing the right comparables is critical. Google's IPO, for example, had to look beyond traditional peers like Yahoo due to differences in their advertising models.

7. Executive Preparedness: Ensure executives are trained on Regulation Fair Disclosure (Reg FD) to avoid legal pitfalls.

8. Public Company Audits: Transition to public company auditing standards early. This often requires changing auditors.

9.Growth Narrative: A strong growth story remains a cornerstone of investor confidence.

10. Early Investor Engagement: Building relationships with potential IPO investors well before the roadshow is essential.

11. AI Story: An effective narrative around AI—how the company leverages and defends against pure play AI competitors—must be simple and free of buzzword-heavy jargon.

Additional Observations

1. Valuation Metrics: The Rule of 40—where a combination of revenue growth rate and EBITDA margin should exceed 40%—still applies in valuing SaaS businesses.

2. Speed Records: Juniper Networks holds the record for the fastest IPO, completing the process in just 12 days.

3. Valuation Multiples: High-growth companies with EBITDA margins over 10% are valued at roughly 2.7x those with lower margins (an unverified claim, but widely cited).

4. Gen AI Use Cases: Finance and legal teams are increasingly deploying generative AI for tasks such as fluctuation variation (flux) analysis, compliance tracking, anomaly detection, and pivot table creation.

5. D&O Insurance Costs: Upon going public, companies face a significant rise in the cost of Directors and Officers (D&O) liability insurance. For example, premiums can jump from $25,000 to $500,000 for the same $5 million in coverage. Furthermore, Test The Water (TTW) presentations should be covered by D&O insurance. 

6. Litigation Risk: Companies are more susceptible to lawsuits in the first three years after going public, largely due to the provisions of Section 11 of the Securities Act.

In conclusion, the Bay Area IPO Summit provided valuable insights into the intricate process of going public, with a clear focus on the evolving demands of growth, profitability, and AI readiness. As the market recovers, companies must prioritize strong growth narratives and maintain a strategic relationship with investors well before the IPO roadshow.

For those not directly involved in finance, legal, or CEO functions, the transformation from S1 to IPO may seem distant. Having held executive roles in product and marketing at both pre-IPO startups and large corporations, the summit deepened my appreciation for the crucial roles my legal and finance colleagues play in navigating this complex journey. Their expertise is indispensable in turning a company’s vision into reality on the public stage.