The Changing Race to IPO

Now, here, you see, it takes all the running you can do, to keep in the same place. If you want to get somewhere else, you must run at least twice as fast as that! —Lewis Carroll, “Through the Looking Glass”

As venture capitalists now run longer footraces towards an exit, we realize that how we manage that holding period will be critical to our success. As “coaches,” we must consider different strategies for our companies to win the day.

Looking towards 2011, the IPO market seems to be carefully finding a new equilibrium and the market is on its way towards recovery. And while the improved pace of IPOs is encouraging, we remain cautiously optimistic as significant challenges remain and the race itself has changed dramatically.

Most notably, the IPO finish line has shifted further down the road. Companies that once needed $50 million to $100 million in revenue to go public now need $100 million to $150 million or more. On the positive side, this higher threshold has resulted in public market candidates that are stronger and yield bigger footprints than ever before.

Yet the additional distance to travel requires more stamina, adding time and often money to the venture capital lifecycle.In this pre-IPO stage, a company should be investing for scale so that it is not just profitable when it goes public but it is also strong enough to compete with the largest players in the field.

Helping companies on that final leg of the journey to IPO will become an increasingly important role for venture capitalists. We must be ready to embrace those strategies that allow our companies to break free from the pack and cross that line victorious.

Better, Stronger, Faster

Later stage growth can be accelerated with the right strategic and geographic acquisitions. While companies have historically relied only on organic growth to reach critical mass, private-to-private sales are becoming more prevalent as a way to achieve a dominant competitive position prior to entering the public markets.

Looking towards 2011, the IPO market seems to be carefully finding a new equilibrium and the market is on its way towards recovery.

With consistently longer paths to exit, not all investors will be in position to go the distance with each and every one of their companies. Accessing the secondary venture market to ensure the most promising IPO candidates have the right mix of investors is a reasonable approach. Similarly, the ability to offer limited liquidity options to founders and employees will relieve the pressure to move too quickly towards the finish line, especially when holding back is the better choice. With the entry of SecondMarket and other players, the secondary landscape has become more competitive and consequently a more viable option for investors and founders alike.

The most articulated fear in the venture world is that the increased time to IPO will compel investors to abandon the early stages in favor of less risky, later stage strategies. Yet, the probability of this happening seems less likely.

In the last year, there has been a renaissance of seed stage firms and super angels whose strengths include executing on capital-efficient strategies early in the company life cycle. While many of their companies will be able to sprint to an early, profitable strategic sale, some may be well positioned to go the distance. For those companies whose opportunity set is large, traditional VCs will follow alongside those seed investors to build a large and dominant company that will be well positioned for a larger IPO.

The venture capitalist’s decision of how best to run this marathon has become extremely important. Identifying those companies that have the potential to scale towards an IPO and being willing to invest further in establishing their dominance, will be critical to success, as will determining which companies are best matched with a strategic buyer. The time for wringing our hands about the longer, more arduous race is over. The winners will be those who put their heads down and move decidedly forward.

Kate Mitchell is Managing Director of Scale Venture Partners and Chair of the National Venture Capital Association. She can be reached at kate@scalevp.com