Going Long

As featured on Fortune Term Sheet

As a junior banker at Goldman Sachs in the early ‘90s I was weaned on the conventional wisdom that growth companies were ready to go public when they reached $100M in annualized revenue (ie, a $25M quarter) and had at least 2 quarters of profitability under their belts.  The “$100M Revenue” theory was based on the idea that a company must be large enough to both (i) withstand competitive pressures and (ii) earn a large enough market value to enable the company to sell enough stock to institutional buyers in its IPO without suffering massive dilution in the process.

This theory makes no sense and, despite the fact that many bankers and VCs still cling to it like religion, there are multiple counter examples debunking the theory.  Growth stage entrepreneurs who want to build long term winners need to take heed.  Going public is by no means the final step to going long.  But, it’s a big step in the process.  Completing an IPO too early can have disastrous effects on the long term health of your business.  Conversely, waiting too long to do your IPO might allow a competitor to steal your thunder.

In my experience, there are three key attributes you must have to consider an IPO.  You’re take major risks if you’re not strong on these three:

• Predictability & Visibility.  If your business is $50M in revenue but you know with high precision what next quarter, or even next year, is going to look like, you pass the test.  On the other hand, even if your business is $200M in revenue, if you can’t reliably predict what’s around the corner, watch out.  Your VCs may have been happy when you hit 97% of plan last quarter.  If you miss guidance or analyst expectations by 3% once you’re public, your stock will likely plummet, often causing employee morale to suffer and competitors to be emboldened. The stakes are high – take the time you need to ensure you’ve built predictability into your company before your IPO.

• Underlying Growth Potential.  When CEOs fall into the trap of thinking the $100M revenue plateau is sufficient to “get out” in an IPO, I like to ask them about their plan to get to $300M or more in revenue.  The IPO is not an end game.  A better analogy – going public is more like moving from college sports to the pros.  You need to ratchet up your game and be ready.  If you’re growing fast and have a large market in front of you, $300M or more will seem like a breeze and public investors will reward you.  If, on the other hand, you eke out growth to $100M without much more potential and go IPO, don’t expect to have a fun run as a public company. The best teams have several tricks up their sleeve for future growth.  You may not know all the growth vectors you plan to open up in the future, but you should have a game plan before your IPO.  The best teams are always investing in several experiments that could augment growth.  You should be encouraged enough by the early results of such experiments before considering an IPO.

• Vulnerability Assessment.  The best companies have no single points of failure.  Do you have a very large customer or two? a dominant supplier or distributor? a huge competitor?  Or, are you beholden to a single platform, technology or regulatory regime?  Any of these concentrations may be fine as you’re building up your business privately, but once you’re public, expect these facts to be scrutinized.  Public investors hate this type of risk.  They’ve been burned many times before.  This shouldn’t be unexpected – when another company realizes you need them, they’ll often extract a lot of value (for example, Facebook and Zynga).  Before considering an IPO, remove single points of failure.  Even if this means growing more slowly for periods of time, the tradeoff will be worth it.

So there you have it, the “Big Three,” an alternative set of requirements to the $100M Revenue Milestone.  If you nail these three, you won’t just get to an IPO, you’ll have a chance to go long as a public company.