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What’s Better for Startups: Seek Private Financing or Go Public (IPO)?

A lot of startup founders see the IPO process as ‘having made it’, but there are considerable risks too.

Global Influencer

Global Influencer
Global Influencer

I work with a lot of startups. The first thing that comes out of their mouths at a first meeting is how much money can we raise?

Typically, startup founders have short-term goals to raise capital fast, grow the business with the seed financing and exit quickly, and with a great deal of cash. There’s nothing wrong with the concept except that some financing options are better than others. While most startup founders look for easy money in the form of family and friends or early investors others have a bigger goal of doing an Initial Public Offering (IPO) and letting the world invest in their new business.

If you look at the area of private equity versus public offerings, many companies that had the goal of ‘going public’ are realizing that finding investors is easier in the private market and without all the red tape private financing makes more sense.

Second Thinking an IPO

A lot of startup founders see the IPO process as ‘having made it’, however, the IPO is a risky proposition, and in my mind, not always the best model to follow. Using private equity to raise money is less stressful, easier to do and you can still raise considerable amounts of investment. An IPO by its nature of being public is subject to enormous external forces, regulations and control issues. Technology companies in particular need wiggle room to explore, experiment and make adjustments. The stock market is averse to seeing too much change in a public company.

If you look at private financing in-depth you will find that it is becoming more popular than traditional investing and certainly a pre-cursor to public companies.

Private financing for your startup can take several directions and can be done in tandem with each other. The most common ways of creating investment for the startup are:

  • Founder’s savings (equity)
  • Friends and family (equity)
  • Government grants
  • Credit cards (debt)
  • Supplier credit (debt)
  • Incubators or accelerators (equity)
  • Crowdfunding/equity crowdfunding
  • Angels – private investors (equity)
  • Offering Memorandums (equity) open to anyone
  • Venture Capitalists – investment firms (equity)

As you can see, there are a lot of options open to the savvy founder and with Angels, and more open OM’s there are tons of investors available with small to large funds.

Angels are private and, by law, accredited investors who invest their own money into a company in exchange for ownership equity or convertible debt. The accredited investor exemption allows startups to raise any amount from qualified investors.

Staying Private Longer

An offering memorandum, according to Investopedia, also known as a private placement memorandum (PPM), is used by business owners of privately held companies to attract a specific group of outside investors. For these select investors, an offering memorandum is a way for them to understand the investment vehicle. While expensive to put together because of the financial and legal due diligence required, it is a very effective way to raise money from anyone with a minimal amount ($5000) of money available to them. This makes private investing for everyone!

Private Financing is certainly a more informal, less structured approach to getting capital. Investors quite often get involved in the business and typically put more money in a startup at this stage because they know that the returns are going to be more lucrative at a liquidity event down the road. The liquidity event is often an IPO but not always. It could be a merger, acquisition or dividend.

Private equity firms have a reputation for getting huge returns for the early stage investor and raising capital is not difficult when portfolio managers can get incentives and the investor can get tax advantages for investing. Having a private equity firm involved also means they have a firm focus on cash-flow, controlled growth and helping the startup because they have the freedom from the restrictive public company regulations and can see the light at the end of the tunnel.

Typically, when a company gets a valuation around the $200M mark they go the IPO route. There are many exceptions, as some founders don’t feel the need to allow global access to their shares. Shopify announced in May 2015, an IPO with a valuation of $1 billion and this was nine years into the business.

According to Bloomberg News, “Canadian technology startups are remaining private longer as an abundance of private capital allows them to strengthen their businesses outside the scrutiny and expense of an initial stock sale.”

Challenges of Being a Public Company

When a startup goes the public IPO route, and I’ve seen lots do it, many issues come into play. Firstly, it takes a large amount of capital to actually go public. The transparency of a public company is great but the other side of that is the massive amount of regulations required to be compliant. You are regulated to the hilt, there’s no way around it and everyone knows what you are doing and how well you are doing financially.

Public financing usually gives the founders visions of vast amounts of cash but it all comes with a price. The dilution of the founders, and all other investors’ shares is a by-product. When millions of shares are put out to the public it often greatly reduces the number of shares of the founders and sometimes control of the startup is lost.

If you, as the founder, can get that vision of the IPO out of your head and realize it is only one route in the journey of your startup, then the running of the business becomes more important because of all the other options open to you.

I know of a Vancouver startup that took the IPO route very early in their company history. Over the past year, they have spent their early investment money and more to keep up the sales of the stock, compliance with the Securities Commission and the ‘dog and pony show’ that comes with the promotion of shareholder stock. The CEO of this company has spent more time outside the country than running the startup to the detriment of the product they were offering.

To me, there is nothing more satisfying that seeing a seasoned founder raising capital as needed, taking care to build a good business then having a much larger corporation with the same vision take over the reins of the company. With a 10x valuation common, the founders, early investors and everyone else connected to the startup gets wealthy. They held their ground and were rewarded. The early investors, big and small hung in there because they knew the startup had a ‘good story’, strong management and growth potential.

The bottom line is private investing is the best bet for founders and investors as long as they understand the huge rewards are there because there is risk in any business.

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