What Does It Mean to IPO

Many startups aspire to IPO. This means they want to hold an initial public offering. If TripleLift is particularly successful, we may do the same. What does this mean? What's the point? What are the pros and cons? 

When a company IPOs, the process is similar - in certain ways - to any round of fundraising for venture-backed companies. The company will issue new shares of stock and sell them to buyers (investors) at a specified price. Like the other rounds (and as previously discussed in the Preferred Shares Lift Letter), this is dilutive to existing shareholders - meaning there are now more shares outstanding than there were previously - and there are certain rights associated with the buyers of the shares.

Seal_of_the_United_States_Securities_and_Exchange_Commission.svg.png

 

If TripleLift were to IPO, all of our preferred shares would convert to common. In our case, assuming the IPO is above a rather low threshold, preferred converts 1-to-1, meaning each preferred share gets one common share. Companies may have very complicated conversion mechanics, but generally the take home is that preferred shares turn into some number of common shares. These common shares are the same as those that are traded on the exchanges - so they too can now be sold. 

There are a number of reasons to IPO, which include: 1) the ability for owners of company stock to freely sell shares, 2) the ability to access the public markets as a whole, which includes selling more equity at a later date, and to obtain debt financing at a scale often not accessible to private companies through debt offerings and the like, 3) vanity, and 4) the elevated reporting and governance standards of public companies (debatably not a "pro").

To be publicly traded means that, literally, the public can trade the stock. It "goes public" on generally the NASDAQ or the NYSE after a whole song and dance where the company woos buyers for the initial offering through a "roadshow" with investment bankers. The company must file a ton of documentation with the SEC about its records, history, risks, prospects, etc - all in the name of public investor protection. After the SEC gives its signoff, the company has its buyers, and the exchange is all set - the stock goes public on a particular day, meaning the ticker corresponds to a certain type of share in a certain company, and buy and sell orders can now run through the exchange's order management system between any parties, at any time that the exchange is open (except right after the IPO, when employees generally have contractual lock-up provisions for between 90-180 days). 

This is markedly different from today's state of affairs for TripleLift, where there's actually no price or value to TripleLift - whereas in a public exchange, it would be traded every second so there would be a regular "market cap" to the company. In order to be publicly trade-able, you have to satisfy all the rules, requirements, and processes of IPO-ing, which we have not done. This also means shares in TripleLift, as a result, are not publicly trade-able. The SEC has requirements on how many shareholders a company can have before it must satisfy the requirements of being publicly traded, as well as the nature of transactions that are allowed - which often means that a buyer of a non-publicly-traded company has holding requirements of several years, if the transaction is permitted at all. All this means that there isn't a ton of liquidity available for private companies nor is there regular pricing information (there are certain, limited exceptions for companies that expect to go public in the not-too-distant future - Second Market being a good example).

That said, it's not all gravy to go public. The SEC has a huge number of intensive, ongoing requirements for any public company, including regular disclosure, quick public reporting requirements, Sarbanes-Oxley, etc. It also means you're now subject to the whims of public market investors who act very differently from private market investors. Private market investors have the restrictions of generally needing to stay in the company for a while, so they have to care about it, to at least some degree. Public market investors have a different set of incentives. Many, like retirement and mutual funds hold shares for a long time. But high-frequency trading and activist investors can change the strategy, board of directors, and senior management of a company with the intent of making a quick buck - perhaps at the expense of long-term strategy. 
But at some level, large successful companies where the shareholders want liquidity for the equity owners will generally need to go public at some point in order to handle the number of likely buyers. There are noteworthy counter-examples, like Koch Industries, Bloomberg, Advance Publications, Cargill, Saudi Aramco and others. These companies are generally family- or state-owned, and produce enough capital for the owners on an annual business that they have no interest in selling shares in the company. 

Preferred Shares

What is preferred stock? How does it impact you, as a startup employee?

TripleLift is a standard corporation, in the sense that it's not a LLC, LLP, general partnership, S Corp, or anything else - so ignore all that, if you've heard anything about those, for the sake of this letter. The company existed on day 1 with only common stock. Each share represented an equal interest in the company. Then we raised money from a VC (the incubator where we got started, which got a little common stock, so they're not relevant for this discussion about preferred shares). VC's will generally invest in a company by buying preferred stock from that company (also convertible debt, but ignore that here). This means that the company issues more stock - the existing stock isn't directly impacted - that have characteristics defined by the preferred terms. 

historic-railroad-preferred-stock-certificate.jpg

 

Preferred shares are ultimately defined by the contracts between the buyers and the company. Typically they include provisions around:

Board Composition - different classes of preferred shares may have the right to elect specified members of the board, and certain members of the board may block certain things the company may want to do if they don't agree with it (generally related to financing). The board does things like approve our annual budget, generally opine on certain strategic matters, and discuss potential financing options - and, theoretically, any liquidation event. 

Liquidation Preference - in the event that TripleLift sells or IPOs, different classes of shares get different dibs on the money. Debt gets its money back first. Then comes preferred shares, then common. Assuming no debt, and the company sells, here are a few scenarios:
1: We've raised $10M and sell for $5M. Single liquidation. The preferred shareholders get all $5M, and common (all employees, including founders), get $0. Sad face. 
2: We've raised $10M and sell for $20M. Single liquidation. The preferred shareholders get the first $10M and the remaining $10M goes to the common. Slightly less sad face. 
3: We've raised $10M and sell for $20M. Double liquidation. The preferred now has rights to twice the money they put in, so they get $20M, common gets $0. Sad face.
4: We've raised $10M on a $100M valuation, and sell for $1B. Triple liquidation. Preferred would get $100M that they were otherwise entitled to, by owning 10%, so the liquidation preference isn't important here. 

When companies get too zany on valuation, VCs respond by stacking preference. So a lot of the companies that get $1B valuations only get them with 5x or more preference. Basically the VC is saying "OK, have whatever valuation you want, buddy, but we're getting 5x our money before you see a cent." A similar mechanism will apply in "down rounds" when VC ownership can ratchet up. 

Dividends - dividends for common stock can generally only be paid from company profits (taxable net income). Not so for preferred shares, which are like debt in the sense that they can have payment obligations. So you might have to pay x% annually, regardless. Or you might have to pay a cumulative amount that would have accrued at x%, sometimes including interest on the otherwise unpaid interest, upon a liquidation event or other specified later date.

Valuation - people get really caught up on valuation, in part because it's a metric of "how _big_ of a company have you got." But hopefully, given the above, you see that it's a fluid conversation where valuation is certainly important, but shouldn't be negotiated in isolation. The valuation is a negotiation, but ultimately the way it's effected is that the company issues new shares for a certain price per share. If we have 100 shares outstanding, and are selling 10 new shares at a price of $5 / share, then you could say the "pre-money" valuation is $500, and the post-money valuation is $550. It's not actually accurate - because the 100 shares don't have the rights that come with the 10 new shares, so they're not "worth" the same $5 as the new shares. So when people ask "what's the company worth" or "what are my shares worth" - it's actually a really complicated question because there's no "true" answer to that (there's a 409a valuation, but that's not exactly accurate for a variety of reasons). But that's why options issued to employees wouldn't be worth $5 in this company. It might be $0.50 or something (valuing options is another topic for another day).