Staying Private: The Road to Startup Success Is No Longer Necessarily an IPO / Starting a Business / Last Modified: February 22, 2017

The standard narrative among startup founders is that IPOs are the final goal, but many founders are choosing to stay private.

The standard gameplan for a young startup seems obvious, even self-evident.

You start small and scrappy, forgoing sleep and usually significant amounts of pay for years until your product starts really resonating with customers.

From there, you find ways to scale up and maximize your reach and in the end, if you can avoid all the minefields along the way, you cash out with a big IPO and take your seat among the big boys of business, right?

That’s the standard narrative around startups in the media, but it’s very rarely how things work out.

And many founders are finding that going public rarely solves their problems, besides bringing in a quick infusion of cash, which, admittedly, is very nice.

That’s why a growing number of tech startups, especially "unicorn" companies (private tech companies valued at a billion dollars or more), are staying private for longer than ever.

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Who's Staying Private?

Let’s look at the numbers. University of Florida professor of finance Jay R. Ritter found that between 1980 and 2014, the average tech company was seven years old during its IPO.

In 2014 alone, however, that age had increased to 11. For comparison, at the height of the dot-com boom in 1999, the average tech company hitting the public market was only four years old, considered extremely young by any standards.

And not only are companies going public later, fewer are going public at all.

From 1996 to 2000, 1,192 tech companies took their stock public. Tech IPOs hit an all-time low during the financial crisis with just six going public in 2008, and while they’re recovered since, they they’re still lagging behind with 204 companies going public from 2010 to 2014.

That’s fewer than any period before the dot-com bubble burst in 2000.

Why Stay Private?

There are plenty of reasons for this, and they break down more or less into two camps: founders who choose to stay private, and founders who are forced to.

If you pay attention to how several tech companies have underperformed in the public market, it’s easy to see why even successful companies may be forced to stay private. For starters, public investors only seem to be interested in hugely successful companies, like Apple, Google, and Facebook.

If you’re a middleweight company with solid performance that goes public, expect to be judged by Mike Tyson’s standards. For mid-sized tech companies, acquisitions have become far more lucrative.

Or, as Ritter puts it in a separate article for Cambridge, “Greater value is created in a sale to a strategic buyer in the same or a related industry.”

For larger companies, there are still disadvantages to IPOs. When you go public, you open yourself up to much more public scrutiny from people who often don’t understand your business and are just looking to cash in.

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Take Twitter, for example. When the social network went public in 2013, the general public treated it like the next Facebook, though there are clear differences in their reach, audience, and ability to monetize.

Despite a number of changes designed to grow the company further, shares have slipped from a high of $69 in January 2014 to around $18.

It’s impossible to tell, but perhaps if Twitter hadn’t treated an IPO as the end of its game plan, things would be different.

What's Next?

Perhaps the most important reason that companies stay private longer, however, is that that IPOs are no longer the only way for companies to cash in on their growth.

Late-stage funding rounds, the kinds that create unicorns by assigning companies truly massive valuations, often earn the nickname “private IPOs” for the large amounts of money they bring in.

And if your company can bring in hundreds of millions of dollars in cash while still remaining private, why even consider taking it public?

And increasingly, many never do. Palantir, the data mining and intelligence startup, just hit a $20 billion valuation after an $880 million round of funding, and yet they reportedly never plan to go public.

For some people in the companies, the differences between IPOs and “private IPOs” are negligible enough to make the nickname accurate.

These large funding rounds are by and large where founders get to start loosening their belts a little bit, and the company itself sees a huge infusion of cash.

Things get different for employees and investors however, due to the types of stock they control. While most startups offer employees stock options, it typically comes in the form of common stock, as oppposed to investors' preferred stock.

That means, in a nutshell, they carry far less risk and will be paid back before anyone else in the event of a sale or an IPO.

This dichotomy has pretty much always been the case, but due to the longer life cycles of private companies, it could be a while before some employees see the cash-in they're waiting for. 

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Ultimately, this difference may mean that we see some changes in how employee stock is treated down the line, but the end result of the trend is that tech companies are going to have a lot more runway to realize their visions fully before they open themselves up to the scrutiny of the public markets.

And for the vast majority of founders, that's a far better deal.

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