The Foundations of Success: From Venture Capital investment to IPO

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“An IPO is like a negotiated transaction — the seller chooses when to come public — and it’s unlikely to be a time that’s favourable to you.” — Warren Buffett

The first modern IPO occurred in March 1602, the Dutch East India Company, a merchant company that marketed between Europe and Asia from spices to slaves. It issued bonds and shares to the public on the Amsterdam Stock Exchange, which could be traded from hand to hand.

From that time until now thousands of companies have taken this route as a way to raise capital to continue their growth and provide a liquidity mechanism for existing investors.

IPO, an exit mechanism

The IPO is not only an optimal mechanism for traditional companies, but also has been used by technological companies such as startups. From 1980 to 2019 there have been 8,775 IPOs in the United States, of which 3,431 were Venture Capital-backed companies and 1,160 from PE. Of this total there were 3,176 technology companies. VC-backed IPOs have increased in recent years. In the 1980s there were 514 backed out of 2,027; in the 1990s, 1788 out of 4,470; and from 2001 to 2021, 1,167 out of a total of 2,258 companies.

The performance of IPOs maximizes valuations at the outset for VCs

Of the total IPOs between 1980 and 2020, the stocks return on the first day of trading was 17.9% and 24.4% average return over a three-year period (buy and hold strategy). In contrast over the same period, IPOs backed by VC capital had a return of 26.5% on the first day of trading and 30.1% over a three-year period, higher than the market average. This is because VC-backed startups are technology-based, implement disruptive business models, and have a dynamic, aggressive, flexible, empowering, and high-performing entrepreneurial culture.

However, despite significant returns, many of the unicorns listed today are not profitable. Compared to profitably data from past decades, recent startups look even worse than already noted. About 10% of the unicorn startups included in figure 3 were profitable, far less than the 80% of startups founded in the 1980s that were profitable, according to Jay Ritters analysis.

Mexico in comparison

In comparison, exits in emerging capital markets are more limited. Take Mexico for example, in the last 11 years there have been around 31 IPOs of companies, none of them involving companies backed by VC funds. Most of these listed companies have been in the market for a long time or are foreign companies.

Among the reasons why an IPO is not a financing option for startups is that on the one hand, the venture market is new in Mexico. Then, the capital market invests outside the country and for most people saving is not even an option.

Therefore, companies such as Lala, IENOVA and Pochteca have recently announced their intention to delist from the BMV.

In the end, whether profitable or not, one undeniable fact is that the growth of startups benefits the economic development of countries. Amazon may have relied almost entirely on external capital for more than ten years, but today it is a public company with a market capitalization of 1.8 trillion and $386 billion in revenue by the end of 2020. It has grown from employing 56 people in 2011 to more than one million people by 2020, worldwide. It has enabled other growth equity stories such as Mary and Larry, one of the first investors in Amazon In 1997.

Venture Capital investment is fundamental in the creation and development of new companies, enabling the development of technology, generating business models that prepare generations for the future, contributing to the development of the country. Furthermore, developing the capital market as an introduction to investment is of utmost importance to accelerate the growth of these companies. This fosters an investment culture and shares the wealth generated by these companies with the wider investing public.

Note: please refer to the original publication at EL CEO: Los cimientos del éxito: de inversión de venture capital a OPI (elceo.com)

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

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

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