The last post, “How Long Does it Take to Build a Technology Empire?” threw cold water on business plans with steep hockey stick sales projections. Data on the top 100 public software companies show that building a successful independent company generally takes time.
It made me think of a related question: If we applied today’s IPO standards to yesterday’s most successful IPOs, what would it mean for the technology industry? The answer bears grim tidings for early stage venture capital.
As mentioned in the last post, the study is based on a large sample of today’s most successful technology companies. This is not an exhaustive list, just a large sample. All of the revenue numbers have been inflation adjusted, so we can compare the performance of a company founded in the 80’s (e.g., Adobe) to one founded a few years ago (e.g., Salesforce.com). There are some interesting findings:
Today’s standards applied to yesterday’s IPOs would spell disaster
By today’s minimum standards for taking a technology company public (roughly: “you must have annual sales of $100 million and be profitable”), the majority of today’s most successful companies weren’t ready to go public until well after their first decade as a business.
The reference lines divide the visualization into quartiles: Upper 25% | Median | Lower 25%. The data show that:
- 25% of today’s most valuable software companies took 13 years or more to reach $50m in sales
- 50% took 9 years or more
- 15% took 5 years or less
Compare this to the term of a typical early stage venture capital fund (10 years). The vast majority of today’s most successful software companies wouldn’t have been ready to go public within the 10 year window of an early stage venture capital fund. Now conclude what you will about the health of the venture industry if the standards for taking a company public don’t change. Worse, if early stage VCs and entrepreneurs accept acquisition as the only route forward, they won’t tend to make the decisions required to build successful, independent businesses.
What really happened
The companies in the study actually took an average of 8.8 years to go public, with a standard deviation of 5 years. The median was 8.0 years. They took an average of 10 years to reach $50 million in annual revenue. Today they are strong companies that have become leaders in their respective fields. It would have been unfortunate for the economy if these companies had been held to today’s IPO hurdle. How would today’s employment statistics have been affected, for instance? Companies need access to public markets in order to raise the capital required to pursue growth plans. Investors need companies to go public so that they can earn a return and then raise funds to invest in the next generation of companies.
Lowering the IPO hurdle may be a function of making changes to the regulatory environment. The standard for going public during the dot.com bubble was certainly too low. And yet it appears we may have swung too far to the other side. Many venture capitalists believe that if we address some of the unintended consequences of financial regulation it will be easier to take promising companies public. Although this is probably true, it will also require widespread changes in investor sentiment. Top tier investment banks insist on the “$100m in annual sales” hurdle because that’s what public investors have the appetite to invest in. Who can blame them after two huge busts?
Will this sentiment change quickly? Perhaps so. That will be the subject of a coming post, “What Will It Take to Go Public In 2012?”
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For a truly meaningful comparison, shouldn’t you adjust for today’s dollars. By looking at how long it took Microsoft or Oracle to hit $50M in the 70′s and 80′s is probably equivalent to looking at how long it takes a company today to hit $75M or $100M if you adjust for inflation.
Steve — Already done. Every revenue figure in the study was inflation adjusted. I adjusted to 2008 dollars for all companies.
Christian,
Neat analysis. My expectation of the stock market is that valuations (PE ratios) will continue to drop until we see the average in the 5-9 range, or about half of where we are today. Accordingly, I’m building my business to generate (gasp!) dividends. Needless to say, it’s pretty much impossible to raise money with that perspective. However, I think having an eye firmly on achieving early profitability is the way to go these days.
I worked for a rocket ship (Pivotal) back in the 90′s, and we spent a ton of cash without ever breaking a profit, primarily because the investors demanded it! I think the venture capital industry needs to come up with some new ideas on what is an acceptable business model, because the 90′s-style hockey-stick is simply not the way of the future.
For many companies there are other (often better) options for follow-on financing and liquidity events than an IPO, (see my comment here: http://www.pehub.com/62156/yelp-helps-kill-ipo-market/ ) so I don’t think the lack of an IPO market is necessarily a problem per se. However I would agree that the existing structure of (most) venture capital is built on the assumption that on average exits will happen after 4-6 years and that no one can take liquidity until exit (ie no secondary sales) is just poor ALM (asset / liability management.)