By Catherine Li
In reality, the process of startups going public is challenging and complicated, in both making the choice to go public and the process of getting there. Actually, going public without real operating metrics is absolutely painful. A company does not grow towards a point where an IPO will just happen naturally; it requires founders who are ready to defend their startup and a plan to transition the startup to a public company.
Before, an IPO was used in the past as a financing vehicle. While that is still the situation for some rare cases today, an IPO now exists for two primary reasons. The first, it provides liquidity to both employees and investors. The second reason is the opportunity to create a currency that you can use to buy other companies in the market or even incentivize others to merge with you.
Margins and Growth: The Numbers
Make sure to have your numbers tightly buttoned before your startup goes public. Wall Street needs to trust your ability to make money and keep making that money; you have to build rhythm and predictability.
To prepare for an IPO, you should focus on two things: gross margins and growth. Gross margin is calculated as revenue minus cost. For example, if you sell a product for $100 that cost you $50 to make, your gross margin is 50 percent. Essentially, your gross margin is the amount of money you make selling a product/service after all costs of the product/service are accounted for. To be a public company, your business needs strong gross margins.
Considering the state of your gross margins, Matthew Howard—a managing partner at Norwest Venture Partners—Wall Street likes predictability. “They would like the gross margins to be steady to slightly improving,” Howard said. Wall Street never likes to be surprised; always consider that Wall Street wants to trust you before your IPO.
If your margins are in good health, you will then also need to consider whether or not they are enough for you to warrant a go as a public company. Howard also claims that if you are a hosted SaaS, your margins should be around 70 to 80 percent and if you are a systems company, your margins should be at 60 to 70 percent. Bear in mind these numbers only function when combined with consistent growth.
Of course, different companies have different definitions of growth. It can include increased revenue, customer acquisition, lowering costs, and among many others. For startups going public, you have to prove that your startup is not stagnant, and that you have a plan for the future. You have to tell your story.
Telling Your Story
A company that wants to IPO should always have a road map. This concept refers to the story that you tell as a company. It’s how you explain how you got to where you are now, but more importantly, it tells you the company direction. This is able to showcase your plan of response to changing market trends. A quality story must exist together with a quality team behind you, a quality legal team behind you, and quality auditors.
When you consider the years of ideas you have thought up for your company, you have to decide if they are empty promises or something you can actually build off of. These plans should add on to the product meaningfully, instead of simply just making it faster or cheaper. As you consider this roadmap, your customers should be the main motivator of each idea you came up with.
When evaluating your startup, often how much visibility and predictability and confidence in your business is the most important. Part of this is the idea that your business should do better than the competition. It is something you have to truly believe gives you an advantage over potential imitators or even current competitors.
Your startup also has to have enough momentum to keep building that advantage even after you have marketed and told the world how great your company is. This cannot be a single, tightly-guarded secret that could undo your company if your competitors ever got a hold of it.
You can’t create a successful future based on your team alone. A rockstar management team is often labeled as competitive advantage, but a good management team should be standard for a successful business.
Making The Decision
If you are still thinking of an IPO, here are just some questions, to consider:
- Have you built a scale or network effects advantage in your product or business in general?
- How do you handle customer acquisition costs and growth with your sales and marketing team?
- Do you have processes built into your business plan that highlight a growth path while accounting for possible change?
While an IPO is a great strategy for a business to expand, it is not for everyone. Some disadvantages of going public include:
- The expenses of going public can be costly. An IPO can cost hundreds of thousands of dollars without any guarantees of passing.
- Subjecting your company to new regulations and rules. Going public means you have to follow governing bodies like the SEC.
- There is now a risk of takeover, since anyone can buy shares of your company—even your competitors.
Your end goal cannot solely be to earn money. Your startup has to follow a vision for where you are taking your customers. While IPOs are necessary for some companies to pay back investors, they are also a resource to better serve your customers.
Be Ready For The Consequences
According to Howard, there is much more of an understanding if a startup misses a benchmark. People know your story with startups, but after a company goes public, there is less sympathy.