The IPO Meltdown

So much for the Year of the IPO.

Starting into the year, analysts and firms alike were brimming with confidence that companies going public—including several big tech names—could raise as much as $100 billion in capital and see soaring stock prices. But so far, they’ve barely attained a third of that, and many have experienced embarrassing headlines.

So who is at fault? Certainly, some of the blame falls directly on a few C-suite leaders with questionable business practices, as well as bankers for setting unrealistic price valuations, and even politicians for creating economic uncertainty. But one group has largely escaped the spotlight: boards.

Experts say directors may want to use the recent struggles to reevaluate, or at least slow things down. “Directors know they have to manage risk, but they typically have limited infrastructure and resources to assess what they should be doing,” says Karen Dempsey, a partner at the law firm Orrick, which has a large practice in taking firms public.

Indeed, speed may be one of the reasons for the poor performance. Stanford University collected extensive data on 47 firms from a variety of sectors that went public between 2010 and 2018. On average, it took nine years from the time those firms were founded to the time of their IPO. Many of the firms planning an IPO in 2019 weren’t even around five years ago.

Some of the major steps toward preparing for the IPO happened as much as five years before the stock was publicly traded, says David Larcker, a Stanford University professor and one of the researchers. Five years out from the IPO, the company often brought on a new CEO (the one who eventually would take the firm public). Four years out, on average, firms installed new financial accounting systems. Much of the heavy lifting, however, occurs three years out. That’s generally when the companies first became serious about developing a corporate governance system, recruited their first independent, outside board members, and recruited a chief financial officer who would eventually take the company public.

Boards may also want to take more time to get the firm’s businesses on more profitable footing. Just 24% of companies trying to go public in 2019 were expected to report positive net income this year—the lowest level since the tech boom and bust two decades ago, according to research from Goldman Sachs. In 1999, a year before the internet bubble burst, 28% of IPOs reported positive net income in the first year as a public company.

Still, many boards want to take their companies public, but experts say they’ll need the proper makeup to pull that off, according to Dennis Carey, cochair of Korn Ferry’s Board and CEO Services practice. The board absolutely must have at least two “strategically correct” directors, Carey says, directors who have intimate knowledge of the company’s industry or sector and can do a thorough analysis of the firm’s strengths, weaknesses, operations, and tactics.

The board should include a former CEO who has shepherded a major corporate financial overhaul, such as a prior IPO, or selling a major part of a business. That person can do a thorough scrubbing of a firm’s financials, Carey says. “Having that leadership around the table can avoid a lot of the issues,” he says.

After the board composition is settled, directors need to ensure that they have a sound investment thesis. That will also act as a double-check on setting a smart IPO offering price. “I think there’s a lot of euphoria amongst directors when they see big dollar signs, cash-outs, huge opportunities to monetize their investments. But you have to be rational and reasonable in setting that initial price of the stock,” Carey says. Indeed, not aligning the business with a sound investment communications strategy could be contributing to some poor stock performances, at least in the short term.

Ultimately, directors also need to ensure that the management and talent systems currently in place are the ones that will succeed in a post-IPO era. Firms must have compensation strategies that will convince key leaders to stick around once the lockup periods that are keeping them from selling stock expire. Carey says an incorrect compensation system can cause a major talent exodus and surprise boards.