Early Investing

What to Do When a Startup Goes Public

What to Do When a Startup Goes Public
By Andy Gordon
Date November 18, 2020

Every investor would love to have my dilemma. One of my First Stage Investor portfolio companies will be listing on a public stock market (also known as going public or IPO’ing) in a couple of months. 

I first recommended this company back in 2016 — and I recommended follow-up investments two more times in the following years. Investors who acted on my first recommendation have seen the company’s valuation go higher and higher. And if they’re anything like me, that produced equal amounts of joy and anxiety. 

Paper profits are nice. But you can’t buy a house or car with them!

So what advice will I provide First Stage Investor members (click here to sign up) when I inform them one of their startups is planning an initial public offering (IPO)? Should they cash out or hold onto their stock? Let’s look at the case for each option.

Cashing out makes some sense. Their return should be in the vicinity of 10x-to-15x. That’s pretty good. It’s also the safest course. Because there’s always the possibility that the company’s shares will go down at some point in the future. 

So why hold and take the chance? 

I have two words for you. Amazon and Apple. Amazon has gone up 2,500x since it first went public. Apple — more than 1,200x. And I think the startup company I recommended is just starting to scratch its long-term upside. 

There’s no consensus on holding versus cashing out early. Venture capital firm Union Square Ventures, for example, tends to cash out early to get as much of its principal back as possible. It’s not only the safest course, it gives fund investors peace of mind.

But is Union Square Ventures leaving money on the table? Possibly. The firm’s co-founder, Fred Wilson, is okay with that. “What’s the difference between a fund that returns 6x and 8x? Other than incremental dollars, not much else. Both are huge successes,” he says.

And while Wilson has a point, he’s a venture capitalist. His funds mostly invest in late-stage startups. When you invest at a $500 million valuation and the company goes public at $3 billion, you’ve made your 6x. If you wait for the company to hit a valuation of $4 billion, you’ve made 8x. Investors that hold in that situation do better — but not life-changing better. 

I understand wanting to sell in that case. It’s not worth taking the risk that $3 billion might shrink to $1 billion.

But early investors like us invest in startups at a much earlier stage — and at a much lower price. When you invest at a $20 million valuation, the difference in profits between a $300 million and a $500 million valuation is huge! A $300 million valuation gives you a return of 15x. A $500 million investment gives you a 25x return. And if the company really takes off and reaches a $1 billion valuation, you’ve made 50x! 

These returns are life-changing. And only early stage investors can make them. It’s why they invest early. But they can only make them if they hold on.  

There’s no right or wrong here. And context is everything. It’s one thing to hold on to shares in a bull market — especially a young bull market that has several more years to go. I sleep pretty well during bull markets, knowing the down days will be more than offset by the up days. 

But investors should be more risk sensitive these days. We’re in a very old bull market that’s about to peter out. Many people think — myself included — that it’s on its last legs. 

All the more reason to cash out before the proverbial junk hits the fan, right? It’s the safe and sensible move. But it flies in the face of what early investing is all about: THE BIG SCORE. And again, context is everything.

This startup is proven. It has a great growth model. Superb leadership. And it’s oozing with upside. Its IPO is not the end of its share growth but very likely the beginning. It plans to quadruple the pace of its acquisitions — which means quadrupling its revenues and quadrupling its valuation (if its price to sales multiple stays stable). 

This is the type of startup investors should embrace. Startups that can potentially give investors life-changing returns are few and far-between. But the risk here is real. 

I haven’t made up my mind yet exactly what I’ll tell these investors. But I can tell you right now, I’m not going to dismiss the value of getting your money back. It’s a big deal. Nor will I turn my back on the enormous upside which is possible by waiting a little longer to cash out. 

Trying to decide just how much money to try and make is a good problem to have. And the last thing I want to do is turn lemonade into lemons. 

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