The Big Dream Going Public in Venture Capital: IPO Process

What founders have to keep in mind is that an IPO is not the end but actually the beginning. — Nithin Kamath, Zerodha

In September 2020 Snowflake made its initial public offering (IPO), raising USD$3.4bn. The company is a cloud data platform that provides a data warehouse-as-a-service designed for the cloud. The company was founded in 2012 and aimed to raise USD$1.4bn in eight capital raising rounds from relevant investors such as Salesforce Ventures, Sequoia Capital, ICONIQ, Redpoint, among others. In its latest round in February 2020, the company raised approximately USD$480mm at a USD$12.4bn post-money valuation. And on the day of its listing, its market capitalization reached a value of USD$50bn.

In 2020 alone, 494 IPO’s were registered in the United States for a total amount of USD$174bn raised. In addition to Snowflake, other tech companies were also listed last year, such as One Medical (valued at USD$1.7bn at the time of IPO), Casper (USD$476mm), Kingsoft Cloud (USD$3.7bn), ZoomInfo (USD$8.2bn) , Vroom (USD$2.5bn), Agora (USD$2bn), Lemonade (USD$1.6bn), mCino (USD$2.8bn), Palantir (USD$22bn), Airbnb (USD$47bn) and DoorDash (USD$39bn).

The initial public offering is one of the exit alternatives that startups have when they reach a consolidation and maturity stage, and it is a way in which investors can obtain their financial profitability. Some of the advantages to carry out an IPO are:

• The company is capable of raising a substantial amount of capital at a lower cost of capital than the financing obtained in previous rounds.
• It means the introduction of a successful model to public investors. It brings the opportunity to build a long and solid investor base.
• Provides a liquid market for the company’s shares. It is the exit opportunity for Venture Capital and Private Equity funds, a liquidity event for founders and the opportunity to issue a pool of shares to attract and retain staff.
• Captures the liquidity premium in the valuation. The public market visualizes the opportunity for capital appreciation, increasing the valuation of the company.
• Provides an acquisition currency for the company to aid future growth. The company, in the event of an eventual acquisition of a competitor or another player in the market, instead of paying cash for the acquisition, can use its shares as exchange currency.

However, there are also downsides to executing an initial public offering, such as:

• The company could end up being overcapitalized due to the need to have a specific number of floating and listed shares on the stock exchange.
• Current investors may have to wait until the expiration of the blocking period to sell their capital stocks in the secondary market and have a liquidity event, being subject to the price of their shares falling during that period.
• Need to maintain liquidity and active trading in the market. Requires coverage of financial analysts, need to generate interest from institutional investors. If not, there could be pressure on the share price.
• The company is subject to market expectations, which will monitor financial performance on a quarterly basis with an emphasis on earnings per share.
• The company is subject to new regulations and market requirements. It must comply with the provisions of the competent authorities, make timely disclosures, including relevant events, and sometimes inside information.

The initial public placement process is outlined below:

1. Solicitation: Investment bankers identify potential candidates to carry out an IPO, study the company and the market, make a pitch that includes valuation, market positioning and commercial distribution. The company conducts a selection process and gives the mandate to the best positioned bank.

2. Structuring: Investment bankers and legal advisors carry out the due diligence process validating the business, its financial, legal and fiscal situation, among others. They determine the parameters of the offer and initiate the preparation of filing documents such as the placement prospectus.

3. Positioning and valuation: Stage to define the history of the company to be told to the market, articulating the most outstanding aspects of the investment. They also address potential investor concerns and build the company’s valuation model.

4. Definition of investor: A list of potential investors is prepared, and the roadshow strategy is defined.

5. Marketing: The placement prospectus and the presentation to investors are distributed. Meetings are held to educate the sales force of each of the underwriting banks. The roadshow begins with individual meetings and group presentations. In addition, the process of building the book begins.

6. Price and allocation: Orders are consolidated, the final placement price is determined, and the final allocation is made to each of the investors.

7. Aftermarket: Operation and trading activities of the stock begin, hoping that little by little it will stabilize over time. Equity research analysts begin continuous coverage of the company to assess the share price, and the company begins a long-term commitment to the investing public supported by a disciplined investor relationship strategy.

Undoubtedly, liquidity events through IPO continue to be of vital importance in the process of divestment of the portfolio of Venture Capital funds, as they are the main strategy to realize the returns generated by startups. Understanding them and knowing their advantages, disadvantages and limitations is essential for a better development of the VC ecosystem in general, for founders, fund managers, and even LPs.

Hector Shibata. Director of Investments & Portfolio at ACV a global Corporate Venture Capital (CVC) fund and Adjunct Professor for Entrepreneurial Finance.

Gonzalo Soriano. VC Investor at ACV.

ACV is an international Corporate Venture Capital (CVC) fund investing globally in Startups & VC funds.

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