The doors to the 2024 IPO window may seem closed for many startups, and while some investors are clamoring for it to open, others may be partly to blame.
In fact, certain terms in standard VC deals may be giving investors too much power to prevent an IPO, according to Eric Weiner, a partner at Lowenstein Sandler. He explains to TechCrunch, “While direct language that explicitly allows investor control over an IPO is rare, common terms in deals can essentially have the same effect.” This means that investors with preferred shares, who have more power than common stockholders, can block an IPO or acquisition if they do not agree with the timing or price.
Ryan Hinkle, a managing director at Insight Partners, adds that before a company can go public, their preferred shareholders, particularly those who set the terms in the most recent funding round, must be on board. In a strong market, there is usually alignment between investors and founders on when the best time to IPO is. However, in the current market, founders might be willing to exit at a lower valuation, while their investors may not be as keen.
“Once a company goes public, their investors’ shares are no longer preferred and they lose certain rights,” Hinkle says. “So, in order for an IPO to go through, the final investor from the last round needs to be on board.” This means that the investor must be content with the company’s current valuation and not expect a higher return.
Hinkle further explains that a “1x liquidation preference” is a common term for late-stage investors to secure higher prices, giving them first priority in repayment if the company is acquired. This poses a problem for startups that have raised funds at high valuations in 2021 and may not have anticipated the influence that their late-stage investors would have if the market declined – which it did.
In fact, Hinkle argues that the market’s performance is not a divine right and shouldn’t be interpreted as such. He says, “We have the right to life, liberty, and the pursuit of happiness. We do not have the right to an upward trajectory.”
Alan Vaksman, a founding partner at Launchbay Capital, agrees and emphasizes that the decision to IPO often sparks conflict between investors and startups. He points out that investors have a fiduciary duty to their limited partners (LPs) to make the most financially beneficial decisions. Therefore, if holding off on going public would generate higher returns, it’s not a smart move for investors to pressure the company.
The nature of public markets is also changing, as Hinkle notes. While companies could previously go public with just eight quarters of strong growth and metrics, the current market demands more. Vaksman adds that the focus has shifted from growth to financials, profitability, and margins.
Besides, the rise of secondary markets also offers VCs an opportunity to obtain liquidity without pressuring their startups to go public during a downturn. This means that founders dealing with indecisive VCs may face tension in the boardroom, but ultimately the delay could lead to better outcomes for all parties involved.
As Hinkle says, “While I initially expected a return to normalcy by now, various factors such as the SVB’s actions and the heightened tensions in the Middle East have instilled fear, doubt, and risk. Therefore, I don’t anticipate a surge of IPOs in the near future.”
