Uncertain Markets Have Startups Rethinking IPOs

"Gloomy economic forecasts, combined with continuing public-market turbulence and a dearth of venture-capital deal making, may have early-stage startups rethinking their long-term goals. For some, that includes the idea that a blockbuster initial public offering is the ultimate prize for venture-backed companies.

Instead, some startup leaders say their objective is to build a profitable company, stay private and eventually buy out their early backers.

Not all investors are on board with the strategy, though many agree that focusing on profitability is a healthier model than growth for growth's sake -- marking something of a paradigm shift after years of chasing lofty private-market valuations through successive fundraising rounds until it is time to cash out.

"We want to build a strong, profitable company that is efficient where we have control of our destiny," said Almog Koren, founder of DogBase, a two-year-old Tel Aviv startup developing artificial-intelligence software to train and handle working dogs.

Mr. Koren said the IPO route has come to feel like a "shell game," in which investors pump capital into fledgling businesses to boost their value, then cash out via a public-market debut. The upshot of that model, he said, is that many startups have "lost what it means to be a solid business."

Mr. Koren said his strategy to pursue profits, rather than a public listing, predates today's slumping markets. DogBase is currently running on advance-sale revenue, among other sources, and is looking to close a pre-seed round later this year, he said.

In a recent survey of early-stage startup founders by startup accelerator Techstars, fielded earlier this year, just 16% of more than 1,600 respondents said their primary goal was to go public, compared with 28% that wanted to stay private and 36% that wanted to be acquired by a large corporate buyer.

Maelle Gavet, Techstars' chief executive, said many startup founders looking at the current IPO market are deciding that it is simply not the way to go for them. "Good founders are pragmatic and flexible," Ms. Gavet said.

Worldwide, 299 startups had IPOs in the first quarter, down from 321 over the same period last year and 512 in the first quarter of 2021, according to professional services firm Ernst & Young.

To be sure, at some point the market will pick up again, Ms. Gavet said, "and when that happens I expect that a lot of startup founders will reconsider their current opinion and look at an IPO as a viable option."

Jonathan Frazier, co-founder of Trustware.io, a Delaware-based blockchain startup launched last year, said he believes the company can raise the kind of funding it would fetch from an IPO by building sustainable revenue streams with solid unit economics.

"This allows us to take more long-term views when making strategic decisions without external pressures from shareholders who might be aligned with us on stock price but not on mission," Mr. Frazier said.

Beyond that, he said, IPOs aren't the most attractive option right now for U.S.-based blockchain companies -- or their investors -- given the recent regulatory clampdown around cryptocurrency markets and token-based assets.

"Current market conditions in the crypto industry -- often referred to as 'crypto winter' -- have made it more challenging for blockchain companies to raise funds through traditional strategies like IPOs," he said. "This has encouraged our decision to remain a private company so we can focus on generating revenue and building real value for our users."

Like DogBase, Mr. Frazier said Trustware.io is largely self-funded, apart from a $120,000 investment by Techstars earlier this year.

For their part, investors are welcoming a return to sound business practices: "This is a clarion call and a chance to cut the hype, trim spending and return to best practices for lean, long-term growth," said David Blumberg, founder and managing partner of early-stage VC investing firm Blumberg Capital. "Instead of excessive focus on negotiating the highest valuation and top-line growth at all costs, it's more important to demonstrate that your business is robust, resilient and properly resourced," he said.

Todd Rahn, a senior managing director at IPO adviser FTI Consulting, said he isn't surprised that startup founders are looking for alternatives to public market debuts.

"During these cycles in my experience, there is a natural attraction to staying private," Mr. Rahn said.

But while the idea of someday buying out your investors may sound good in theory, Mr. Rahn said, it is another thing in practice: "Even in a positive cash flow and profitable scenario, it would take a substantial amount of time to build the amount of capital needed to buy out investors."

Indeed, relatively few VC-backed companies become cash-flow positive within 10 to 15 years of the initial VC investing, said Jay Ritter, a finance professor at the University of Florida who tracks IPO activity. By contrast, VC funds typically promise exits within 10 years of the fund's formation, with occasional extensions to 12 years, he said." [1]

1. Uncertain Markets Have Startups Rethinking IPOs
Loten, Angus.  Wall Street Journal, Eastern edition; New York, N.Y. [New York, N.Y]. 02 May 2023: B.5.