Late-Stage Startups and the Choice between Acquisition and IPO

The road to success for late-stage startups often leads to a critical crossroads - the decision between acquisition and initial public offering ( IPO ). This choice can be challenging, as both options present unique advantages and disadvantages that must be carefully weighed against the company’s specific goal and vision. Acquisition and IPO are different paths that startups can take to achieve an exit, allowing founders, investors, and employees to realize the value they have created.

Acquisitions: A path to certainty and integration

An acquisition might be the perfect path for late-stage startups seeking integration and certainty. Becoming a part of an established company offers access to many resources and market reach. This can be attractive for startups facing challenges in funding further expansion.

 However, Acquisition also brings the prospect of losing control of the company. The acquiring company may have its own strategic priorities and norms, leading to losing the startup's original vision. 

An example of a well-known company who got acquired is WhatsApp. It was acquired by Facebook in 2014 for $19 billion.

What are the Advantages and Disadvantages of Acquisitions?

Acquisitions offer many advantages to startups:

• Improves the economies of scale: When a large business acquires a small business, it is likely to have higher material and supply requirements. A business can lower material costs and improve its economies of scale by purchasing raw materials in bulk.
• Provide more financial resources: In a business acquisition, the two companies involved can combine their financial resources to increase the financial capacity of the new company. This can also lead to new investment opportunities and help the company reach a broader audience base.
• Increases market share: When two companies operate in the same market or provide similar products, they can create a synergy that increases the market share of the newly formed company.
• Enhances distribution capacity: An acquisition might help expand a company geographically, enhancing its ability to distribute goods to a new market. This can lead to increased sales and revenues.

The acquisition also offers some disadvantages to startups:

• Lost Opportunities: Companies may spend a significant amount of time, money, and energy on acquiring a business, potentially leading to the loss of other promising opportunities.

• Layoffs: The acquiring company may lay off some of the startup's employees to reduce costs. 
• Loss of focus: The acquiring company may focus on integrating the startup into its operation rather than investing in its long-term growth.
• Loss of autonomy: When a startup is required, it typically loses its autonomy and becomes a part of a larger organization. 

IPO: A path to independence and market recognition

An initial public offering ( IPO ) is the first time a private company sells shares of its stock to the public. This allows the company to raise money from investors not part of the company, granting access to a broader pool of investors and credibility in the market. This can be attractive for startups seeking to expand their product offerings and enter new markets. 

So, how does an IPO work? When a company is ready to go public, it will begin to advertise its interest and start the process of meeting the SEC’s ( Securities and Exchange Commission )  requirements. This statement must include detailed information about the company’s business, financial condition, and management team. 

After learning how it works, you must know the steps to an IPO :

1. Decide to go public: When a company decides to go public, it embarks on the IPO process that involves evaluating its financial and business models within the context of current market conditions. Before launching the IPO, the company must compile a comprehensive IPO checklist encompassing all crucial aspects and essential documents.
2. Select a Lead Underwriter: Investment banks often forge strong relationships with companies aspiring to go public. As the time draws near, the company approaches its preferred investment banks to request a formal proposal for the initial public offering. Then, the firm evaluates the received proposals and selects the lead underwriter based on the suggested offering price, type and quantity of shares, and marketing offer timeline.
3. Hold a Kick-Off Meeting: This crucial phase of the IPO process, brings together all stakeholders to engage in discussions surrounding critical facets of the deal, such as the offering price, due diligence procedures, necessary registration forms, and filing timelines.

1. Red Herring: The necessary documents have been filed and thoroughly examined, enabling the IPO team to create marketing strategies to promote the upcoming offering. The objective is to attract investors willing to acquire shares of the issue. To this end, the company may publish a preliminary prospectus (red herring), providing potential investors with valuable insights into the business and the purpose of raising new capital. 
2. Book Building: In parallel, the investment bank undertakes the task of ‘building a book’ by inviting financiers to indicate their desired purchase price for the securities. These bids are not actual orders but intentions of interest. This step aims to gather and record investor demand for shares before determining an issue price acceptable to both the issuer and the market.
3. The IPO Roadshow: Throughout the book-building process, underwriters and the management team participate in the initial public offering roadshow to promote the shares and gather investor feedback regarding pricing. This is when investment banks begin accepting orders from investors and leverage this information to update the filing statement.
4. The IPO Pricing: It’s time for the SEC to approve the IPO, and the parties involved are finalizing the effective date. One day before the official launch, the company's management and the lead underwriter will meet to close the order book and determine the final offer price and the number of shares to be sold.
5. Allocate Shares to Investors: With the IPO pricing finalized by the company and the lead underwriter, the equity syndicate allocates the shares. Typically, a significant portion of the offering is directed towards institutional investors, while the remaining shares are made accessible to retail investors
6. Start Trading: On the official IPO date, the agreed number of shares is released, and the general public can start buying and selling the IPO stock.
7. Manage the Post-IPO Period: After the initial issue, investment bankers provide analyst recommendations and manage after-market stabilization. If necessary, they must create a market for the stock.

However, an IPO can be expensive and demanding. The ongoing pressure to meet quarterly earnings expectations can constrain the company's ability to invest in long-term initiatives. 

An example of a well-known company that went public is AirBnb in 2020 at a valuation of 47$ billion. 

What are the Advantages and Disadvantages of an IPO?

IPO offers many advantages to startups:

• Access to Capital: One of the primary reasons companies go public is to raise capital. By selling shares to the public, a company can generate significant funds, which can be used for various purposes, such as expansion, research and development, debt reduction, or acquisitions.

• Enhanced Visibility: Going public increases a company's visibility and credibility in the market. It can attract attention from investors, customers, and business partners, enhancing the company's reputation.

• Liquidity for Existing Shareholders: Existing shareholders, such as founders, early investors, and employees with stock options, can monetize their holdings by selling shares on the public market. This provides liquidity and allows them to realize the value of their investments.

• Employee Incentives: Publicly traded companies can use their shares as part of employee compensation packages, including stock options and employee stock purchase plans. This can help attract and retain talented employees.

IPO also offers some disadvantages to startups:

• High costs: IPOs are expensive, and maintaining a public company is ongoing and usually unrelated to the other costs of doing business.
• Management distraction: Fluctuations in a company's share price can distract management, which may be compensated and evaluated based on stock performance rather than actual financial results.
• Increased disclosure requirements: The company must disclose financial, accounting, tax, and other business information. During these disclosures, it may have to reveal secrets and business methods that could help competitors publicly.
• Limited flexibility: Rigid leadership and governance by the board of directors can make retaining good managers willing to take risks more challenging.
• Alternative options: Remaining private, soliciting bids for a buyout, or exploring other alternatives may benefit some companies.

Dual-Track Processes 

Companies can simultaneously consider going public and acquiring through a dual-track IPO approach. 

So how does the dual-track work? Investors have an endpoint in mind: An exit and liquidation of their stake in an investment (the company). Therefore, it's understandable that they aim to maximize their investment returns while acknowledging the inherent risks associated with the IPO process. 

This is the purpose of the dual-track IPO. The specific approach varies depending on investors' objectives. By simultaneously exploring IPO and Acquisition deals, companies gain flexibility and options. The process is flexible, as each company's circumstances are unique.

 The dual-track process generally involves two teams: one responsible for IPO preparation, including underwriters, and another focused on identifying potential acquisition partners. Once regulatory approval for the IPO is secured, the company can evaluate its options and decide whether to go public or pursue an acquisition deal.

What are the benefits of Dual-Track processes? 

Here are some of the benefits of the Dual-Track processes :

• Flexibility: The dual-track process empowers companies to explore going public and pursuing an acquisition deal, providing them with more excellent options and avoiding being constrained to a single exit strategy.
• Maximises odds of a higher valuation: Additional options mean multiple valuations can be on the table. For instance, a private deal may value a company more than if it were to IPO. For investors, getting an idea of a company’s ultimate value from multiple sources can illuminate them, and they may learn of exit opportunities that they did not previously recognize.
• Mitigates risks of the market: By pursuing a dual-track approach, companies can mitigate the risks associated with placing their entire exit strategy on an IPO. Market conditions can be unpredictable and can significantly impact an IPO's outcome. The option to pursue an acquisition deal provides a protective layer against unfavorable market conditions and allows companies to avoid going public at an inopportune time.

How can startups make the right choice?

When deciding between Acquisition and IPO, startups should consider the following factors: 

• Company and culture vision: Does the startup's vision and culture align with potential acquirers?
• Strategic fit: Does the acquisition enhance the startup's competitive advantage and strategic goals?
• Management team and expertise: Does the management team have the experience and capabilities to manage a public company?
• Market conditions and investor appetite: Are market conditions favorable for an IPO, and is there strong investor interest in the startup industry?
• Customer relationships: How will customer relationships be affected by an acquisition or IPO? Will the company provide its customers with the same level of service and support?
• Innovation: Will the company be able to continue to invest in research and development and launch new products and services?

The decision between Acquisition and IPO is a strategic one. Startups should carefully consider all of the factors involved before making a decision. It is also advisable to consult with experienced advisors such as venture capitalists and investment bankers.

Balancing between IPOs and Acquisitions

 In conclusion, deciding between acquisition and initial public offering (IPO) is pivotal for late-stage startups, presenting a choice with unique advantages and disadvantages.  Understanding the advantages and disadvantages of each path is crucial. To navigate this critical crossroads, startups can also consider a dual-track process, allowing them to explore both IPO and acquisition options simultaneously.  

Lastly, the right choice depends on the company's vision, strategic fit, management expertise, market conditions, customer relationships, and commitment to innovation. A thorough evaluation and guidance from experienced advisors is essential for startups to make a well-informed decision that aligns with their long-term goals. In the dynamic landscape of late-stage startups, the choice between acquisition and IPO marks a strategic maneuver that shapes success in the competitive business environment.