Why private companies are delaying IPOs, and why we need a new definition for ‘Technology’

The well-known and highest valued Tech companies are delaying IPOs (think Uber, AirBnB, etc)

According to McKinsey research, at the end of 2015, 146 private Tech companies were valued at ‘unicorn’ status–(a private valuation of $1 billion or more). Clearly, the private market for Tech companies is skyrocketing; in fact, Tech investors laid down $76 billion in investments in 2015 vs. $26 billion in 2013.

There are many reasons as to why the private market is growing, valuing more and more companies upwards of $1 billion through late-stage investment rounds (justifiably or not). However, I’d like to focus on why so many companies are opting to delay going public, and why they will eventually IPO.

Why these companies are staying private:

  1. The first, and most obvious reason, is that U.S. law changed to increase the max # of shareholders allowed for a private entity. Previously, just 500 shareholders were allowed before an entity needed to go public, now a business can have up to 2000 investors. Companies like Facebook and Google were essentially forced to IPO as they triggered the 500 shareholder limit; that limit has just quadrupled, greatly extending the window companies have to operating privately.
  2. Second, staying private offers the advantage of being able to focus on long-term strategy, rather than short term quarterly earnings reports. Once a company IPOs, earnings growth is expected, and improvements each quarter into perpetuity are demanded from Wall Street investors; you can see how this would not blend well with some of these large private Tech ‘startups’, who are much more focused on generating user growth and network effects for the time being, opting to forgo large chunks of profits until they reach desired scale.
  3. Third, most private Tech companies offer their employees a combination of cash (salary) and equity-based compensation. The employees then can’t liquidate this equity until the company goes public (though some do allow private market share liquidation), meaning they are essentially tied to the company until it IPOs; this can be an effective strategy to reduce attrition and keep talent in-house much longer than industry averages.

Why they will eventually move public:

  1. As mentioned,  the max # of shareholders an entity can have before moving public has increased to 2000. However, it’s still a max, and will no doubt trigger a lot of the private unicorns into going public.
  2. Although a lack of liquidity can be beneficial short-term to keep talent in-house, having liquidity will eventually be desired as some of the company leadership wants to cash out, and will be necessary to scale the company up and bring in new talent as the market catches onto this private equity trap.
  3. Going public will allow for easier financing, allowing the now-private companies to scale their businesses even larger with much less difficulty. Take Elon/Tesla, for example, he’s able to make significant capital investments, and even acquisitions (SolarCity), using his public market cap.  Elon has been able to swing up market cap based on forward-looking statements and pre-orders, which has been an extremely powerful tool for his company and is core to Tesla’s future success.

Although the ‘unicorns’ are staying private, worth noting that the number of Tech IPOs is not decreasing

Lately, there has been plenty of news focusing on the lack of Tech IPOs. I decided to dig into this, grabbing IPO data from the NASDAQ and NYSE, and found that the # of Tech IPOs is not as low as some make it out to be. While it’s certainly true that many of the more famous ‘unicorns’ (Uber, Pinterest, Palantir, etc) have been delaying their IPOs, I think it’s important to note that the # of Tech sector IPOs has still been quite high, hovering between 20-40 per year over the past 5 years.

Screen Shot 2016-07-29 at 9.29.28 PM

In the above chart, note that as a % of total IPOs, Tech sector IPOs are indeed decreasing; I will address this towards the end of this post.

The definition of Technology needs to go:

The below heat map shows the # of IPOs per year, by sector:

Screen Shot 2016-07-29 at 9.55.41 PM

 

Cutting the data to show the last ~15 years:

Screen Shot 2016-07-29 at 10.02.37 PM

 

From the chart, we can clearly see that both Healthcare and Finance have had a ton of IPOs in the last ~3 years.  Digging into the growth in Healthcare IPOs, specifically, I noticed something interesting: technology was the driving influence of many (>30%) of the Healthcare IPOs. Of the list of Healthcare IPOs, nearly a third were coming from either Biotechnology, Healthcare Electronics, or Healthcare Instrument companies. It can be argued that all three of these industries utilize and rely on technology to a high degree.

[for those interested in deeper dives into Healthcare, check out my last two posts: (1) Healthcare expected to grow faster than any other industry through 2024 (2) Two forces driving Healthcare’s growth]

What exactly is Technology, anyways?

Technology is defined as

“The application of scientific knowledge for practical purposes, especially in industry.”

Using this definition, it becomes apparent that companies scattered across nearly every sector could quality as “Tech” companies. Perhaps although the dictionary definition is pretty open-ended, the definition of the Technology sector as defined by the markets is more complete. Taking the definition of Technology sector from Investopedia:

“The technology sector is the category of stocks relating to the research, development and/or distribution of technologically based goods and services. This sector contains businesses revolving around the manufacturing of electronics, creation of software, computers or products and services relating to information technology.”

Blurred lines:

From the above definitions, we can see the line really beginning to blur regarding what’s a Technology company and what’s not. Take a company like Uber, for example–Uber provides logistics/transportation services directly to consumers, but considers itself a Technology company since its business has been enabled by technology, and it’s a critical component of Uber’s future success. Another example, Amazon, essentially began as an online bookstore and eventually transitioned into a full-fledged online retailer known for its world-class logistics (ignoring their recent Cloud offerings). Rather than initially being labeled as a publisher or retailer, Amazon has been deemed a Technology company from the start, since their business was enabled by technology.

Technology has already drastically changed Retail and Transportation (among other industries), and is quickly becoming a core component of every company’s strategy, agnostic of industry. Every major company will eventually need to adopt the latest technology in order to stay competitive over the long-term. This brings us to my core problem–if every company needs to adopt technology in some way, and the definition of a ‘Technology company’ is already so loose, one can eventually argue that every single company is a Technology company, rendering the label useless. Finance has already run into this to some degree, creating a hybrid industry, FinTech, to describe companies that ‘use technology to make financial services more efficient’; I’d argue that every company in the Financial sector is, to some degree, attempting to use technology to improve efficiency. Are we going to start calling Oil and Gas companies who leverage technology to find new drill sites OilGasandTech companies? Or are Consumer Products businesses who adopt the latest automation technology into their factories going to be named ConsumerProductsTech entities? Where does it end?

Clearly, there needs to be some refining of the definition of what constitutes a Technology company and what doesn’t. I don’t have a perfect answer, and perhaps a new term will present itself eventually. For now, I think Technology companies should be limited to those who are solely in the business of creating and selling technology, while all of the businesses who leverage technology to gain a differentiated advantage in a given industry should remain, well, in the industry they are attacking.