Nothing seems to spark people’s imagination and create excitement on Wall Street as an initial public offering. The is filled with potential, giving investors a chance to dream of big things. Taking a company public is a big step. For the people who got in on the ground floor, it can mean instant wealth in the form stock options. For investors, it can mean a chance to grab up shares in a company that, if all goes well, might be taking off to bold new places as it picks up an influx of new capital from selling shares. Now, the entire investing world waits with baited breath as Facebook (FB) prepares for its massive IPO next month.
Reasons for Concern
However, for all the excitement surrounding an IPO, there are ample reasons why a company shouldn’t rush into one. The cost, for instance, is not inconsequential with average costs exceeding $3.5 million. Once public, it costs an average of $5 million a year to maintain that status. The IPO also can draw attention away from other important company business as management has to go through a number of crucial decisions from pricing to selected an underwriter. It also means that a company is giving up a certain degree of control. An IPO means that the company, now public, has stricter reporting rules for its accounting and, hypothetically, could ultimately get taken over by a different management group.
The most recent wave of internet IPOs seems to have demonstrated many of these concerns fairly clearly. Groupon (GRPN), in particular, has come under criticism recently over what some see as an IPO that came too early. The company was only three years old when it went public, and a failure to anticipate the return rate on certain big-ticket items forced the company to restate its Q4 earnings mere months after its IPO. The company is also expanding into new revenue streams, already seeking out new ways to make money.
“Even as a fairly big Grouponcritic let me be clear: Most of Groupon’s woes go back to one serious misstep. It went public years too early,” says pandodaily.com’s Sarah Lacy. “There is no company in the world that goes from zero to $1 billion valuation — the fastest growing ever, gushed Forbes in 2010 — in less than two years without having serious stress fractures, business model questions, and management team issues. None. That’s like a kid growing a foot overnight and not having stretch marks and leg cramps. Even the Valley golden child Facebook had issues two years in.”
Growing Pains Lead to Lack of New IPOs
While the names of prominent companies going public in the last year are familiar, from Pandora (P) to LinkedIn (LNKD), the total number of IPOs appears to be on the decline. President Obama entered the fray, though, in signing the JOBS Act on Thursday, April 5th, which is geared towards rolling back regulations in an effort to promote new business start-ups and IPOs.
“Overall, new businesses account for almost every new job created in America,” said Obama at the bill signing. ”For start-ups and small businesses, this bill is a game changer. Because of this bill, startups and small businesses will have access to a bigger pool of investors.”
However, not everyone is thrilled about the changes. The SEC regulations involved were written for a reason, and removing them could create a more dangerous environment for the investor.
“This legislation will unleash a new wave of damaging investment fraud, undermine market transparency, and increase the cost of capital for the small companies it purports to benefit,” said Barbara Roper, director of investor protection at the Consumer Federation of America. “Unfortunately, both the administration and a bipartisan majority in Congress have chosen to ignore those warnings.”
What Does This Mean for Facebook?
Regardless of whether Groupon went public too early or Obama’s new bill is a smart idea, Facebook is still due to go public in the next month or so and it looks to be the biggest internet IPO ever and among the largest IPOs of any kind to date. But is Facebook making progress? Sarah Lacy, for her part, seems to think the massive social network has managed to avoid the issues that appear to be plaguing Groupon.
“Think back to how many scandals Facebook has endured over its lifetime: Presumptive founders wanting payouts, privacy scandals, business model difficulties, and many, many iterations of its senior management team,” she wrote. “Facebook spent the first few years of its existence shedding full teams of managers, like a snake annually shedding its skin, until finally it hit on the right team to lead a $100 billion company. Facebook waited for it all to come out of the closet and for all its internal issues to get solved before it invited public shareholders to the party.”
If she’s right, it might be possible that Facebook’s hypothetical $100 billion valuation is rooted in reality. If not, well, there’s likely to be a lot of very disappointed investors this time next year.