Does IPO Stand for “Irresponsibly Promoted Obscenity”?


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Groupon postponed its IPO.  No surprise. The company, once a darling, retreated when investors raised serious questions about its earnings. Now it’s in pre-IPO quiet period again, so it seems to be a good time to discuss this.

We are playing a dangerous game with IPOs today, possibly one more dangerous than the pre-burst gold rush of stock prices in the late 1990s. Here’s why:

1)    In the pre-IPO phase, when a company is still privately held, it raises exceedingly large sums of money. Thus its valuation is pumped up to the stratosphere. It is justified? Does revenue support it? When a new investor puts in $1 billion into a startup, the company’s valuation becomes $1 billion plus whatever its value was prior to the investment. It’s not hard to see how a company with no revenues could, after multiple rounds of financing, have a book valuation of $20 billion.

2)    In the pre-IPO phase, due to SEC guidelines, the company’s financial data does not have to be released. The hype-balloon can be pumped with hot air, leading the novice investor to believe that the ‘value’ of the company equals the money it’s brought in.

3)    The net worth of the founders jumps into the billions, not because of how well the company is doing, but rather the value of the financing. How does that impact their motivation to innovate?

4)    The hype grows. Early investors see their investments jump by 1000%. Early investors are selling tiny percents of their equity for massive returns, creating a false market within  a pre-IPO company, all the while the company finances are still a mystery. This creates a micro economy where investors are getting rich NOT based on how well a company is doing but because the hype is so overheated that other investors will pay anything to get in on the action.

5)    More VCs, angels and banks want in. The fever is out of control.

6)    The market perceives the value of the company as high based on…nothing.

So Groupon announces its IPO in the wake of fawning, incredible media coverage. Everybody swoons.  Then the SEC starts looking at the numbers and…whoops. Not only were revenues $600M less than expected, but Groupon was counting gross revenues rather than only considering its take after paying the businesses whose coupons it sold. Double whoops.

The market makers assume that the public is unintelligent and greedy, when more often than not it’s the skeptical bloggers and others who blow the whistle on this shell game. I respectfully exclude Facebook, which has done all the right things.  Yes, its valuation is off the charts, but it is justified because it is the dominant platform in a booming space. When Facebook goes public, it will almost certainly support its soaring valuation, because its management has not chased the gold rush.

As an entrepreneur and investor, I am all for the free economy and living the dream. However, technology is not about creating hyped-up IPOs. It’s about innovations that change the world. When the sole purpose of building a company is to create a hype cloud that makes a very few rich while screwing thousands, that is the opposite of progress.

 

 

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