Illustration: James Clapham

The Counterintuitive Case for Companies to Stay Private

IPOs used to be a company’s hot coming of age. Now they are more like a company settling into middle age.

TThe IPO used to be a coming-of-age ritual for new companies: They’d grow up a bit sheltered, raising money from venture capitalists and making their big mistakes in private. Then, at the right time, they’d make their public debut, throw a huge party, and become a real Grown-Up Company for the first time. It’s also a moment when employees and early investors go from theoretically rich to having money they can actually spend.

Pre-IPO, an engineer might know what percentage they own of a company’s stock (due to dilution, this percentage is an upper bound on how much they actually own), and they might know what the company was worth the last time it raised money (due to the dynamics of deal structure, PR, and journalism, this is also an upper bound on how much the company is worth). But after the IPO, you can do some simple long division and convert the cost of a vacation, new car, or new house into a certain number of shares, and quickly convert those shares into cash.

That’s changed. Today, going public is more like becoming middle-aged: It happens gradually, and it entails a transition to a more mature, established phase of the corporate life cycle. Decades ago, companies went public early in their life. Microsoft, a relative late-bloomer, IPOed in 1986, a decade after it was founded, at a market value of $520 million. Today, Microsoft is worth about $1.3 trillion: 99.96% of its market value was created post-IPO. In 2012, Facebook went public, a bit under a decade after it was founded. Its value at IPO was $104 billion, compared to $580 billion today. Investors aren’t complaining, of course, but this means only 82% of its growth in value happened as a public company. The picture is worse for more recent IPOs, like Uber (trading below its peak private valuation), or WeWork (which hasn’t managed to go public at all).

You could have made a life-changing amount of money buying Microsoft stock the first day it traded, but it’s very hard to get rich investing in something that’s already worth $100 billion.

Of course, the comparison is somewhat unfair: Microsoft has been a public company for three decades, while Facebook has been public for eight years. Compound interest will do its thing, and more of the wealth created by Facebook will accrue to people who invested when it was public. But even so, it’s clear something changed. You could have made a life-changing amount of money buying Microsoft stock the first day it traded, but it’s very hard to get rich investing in something that’s already worth $100 billion.

What changed?

The short answer is: That Microsoft story I told above is a story people know, and a story they reacted to. Today, companies stay private for longer: There are more institutions that want to invest in private companies, and changes in regulations have both made it more convenient to stay private and less convenient to go public. And it’s a story about a broader truth: Anything known to be cool is doomed to become lame.

It’s more fun to stay private

Why do companies go public in the first place? To raise money, to reward early investors and employees, maybe to goose PR for a little while, and because past a certain size it’s weird not to. This has always been broadly true: U.S. mutual funds manage about $18 trillion, while venture capital funds have about $400 billion. One of these numbers is obviously a lot bigger than the other. On the other hand, you’ll notice that both numbers are enough to fund any viable business you can think of. Uber raised $20.7 billion as a private company, including debt. That’s less than 5% of all venture dollars available, and Uber was an exceptionally voracious company.

But even that is an overestimate of how big a chunk of venture dollars Uber absorbed: They raised early rounds from traditional VCs like First Round, Benchmark, Lowercase Capital, and Menlo Ventures, but by the end the big checks were coming from entities like Microsoft, Saudi Arabia’s sovereign wealth fund, hedge funds, and SoftBank.

If the point of an IPO is to get access to new investors, the question is: Who’s left? Fidelity owned Uber stock before the IPO, and actually owned enough to help force out Travis Kalanick. T. Rowe Price invested in 2014, half a decade before the IPO. Hedge funds already owned it. Earlier in Uber’s existence, plenty of rich individual investors bought shares, too. Morgan Stanley put together a fund called New Riders in 2016, allowing their high net worth clients to buy Uber stock.

Why do companies go public in the first place? To raise money, to reward early investors and employees, maybe to goose PR for a little while, and because past a certain size it’s weird not to.

The only constituency that didn’t have some way to get into Uber was the small investor who didn’t want to own mutual funds. That’s an interesting category — it describes the majority of amateur finance bloggers, for example — but it’s not a huge one.

Maybe instead of looking at Uber’s demand for money, we could ask about early employees: Did Uber need to go public so they’d have actual cash rather than hypothetical wealth? Not really. There was an active market in Uber stock even before the IPO, and SoftBank bought shares in bulk from employees.

Before Uber, the leading semi-public pre-IPO company was Facebook. Like Uber, it acquired a hefty valuation while still private, leading to a robust secondary market in Facebook stock. There are lots of companies that built themselves entirely on Facebook’s platform — Zynga, Plenty of Fish, a handful of adtech plays — but Facebook might have been the first company that was so successful it led to the creation of another company specifically to trade its stock. (In a weird financial ouroboros, that company, SecondMarket, raised $15 million from Chamath Palihapitiya, a former Facebook executive.) Facebook pioneered the private company stock trading infrastructure that Uber used to such great effect. Like Uber, there were secondary transactions (DST Global bought shares from early Facebook employees and investors as early as 2010). Like Uber, there was a special-purpose investment vehicle: At the beginning of 2011, Goldman invested $450 million of its own money and raised another $1 billion from clients to invest in Facebook.

In fact, Facebook’s high-wire pseudo-public-company act was so successful and so attention-grabbing that newer startups carefully craft rules to restrict pre-IPO selling. Airbnb, for example, allowed employees to sell stock in 2016 in exchange for agreeing to stricter limitations on future sales.

The legal regime has also changed. A long-standing rule stated that once a company had $10 million in assets and at least 500 shareholders, it had to start filing with the SEC as if it were public starting four months after the beginning of their next fiscal year. This was one of the reasons Microsoft went public, and was probably why Facebook’s Goldman deal closed in early January 2011; Facebook went public in the spring of 2012, right on schedule. In 2016, the shareholder limit was raised from 500 to 2,000, meaning there was one less catalyst for early IPOs.

Before there was a robust market in pre-IPO stock, early employees of growth companies would encounter a strange wealth air pocket: They had enough money to retire, at least on paper, but their below-market salaries meant that they couldn’t spend the money. And there was always the chance that it would go away; plenty of dot-com employees in the year 2000 saw their net worth go from zero to $10 million back to zero, while their actual spending money stayed firmly in the middle-class range. When VC was smaller and traditional asset managers didn’t get involved in private markets, growth companies hit an air pocket of their own: They were still in investment mode, but no venture capitalist could provide them with enough funds.

Today, that’s all changed. If a company is big enough that its early employees are nervously hoping to turn their monopoly-money options into real money, they can; if the next round pushes VCs to the limit, hedge funds and mutual funds are ready. The structure of the market has changed, and companies can wait a lot longer to go public.

It’s less fun to go public

An IPO is a big party, but like many of life’s big parties — graduations, weddings, Mardi Gras — it’s a celebration that recognizes the start of a huge obligation. The basic thrust is “Sorry to hear that. Would champagne help?” (In his memoir, Jim Cramer makes it sound like TheStreet.com’s IPO had him feeling hungover even before the party started.)

What does an IPO force you to do?

  • Traditionally, it involves a “lockup”: a six-month period in which early employees and investors can’t sell stock. This is not a strict legal requirement; it’s just a tradition, which actually makes it harder to violate. The finance industry is full of clever lawyers who can find loopholes in rules, but no amount of textual parsing can identify loopholes in social norms.
  • Public companies have to report earnings quarterly, and promptly disclose any “material” news — that is, the bad news they’d rather not talk about. Think of the IPO process as a way to become an inverse Instagram celebrity, where instead of faking the lifestyle you wish you had you have to give a full accounting of the parts of your life you wish weren’t real.
  • The process of filing for an IPO is perfectly designed to maximize bad press: In a prospectus, the company has to disclose every conceivable risk factor, so they don’t get sued if something bad happens. And, to avert promotional behavior from management, the SEC imposes a “quiet period” before the IPO, during which the company can’t talk to the press. (Sometimes the quiet period gets violated; famously, Google’s founders gave an interview to Playboy that was published during the pre-IPO quiet period. And Chamath Palihapitya — that guy again! — talked up Slack during that company’s quiet period. In both cases, the company had to grudgingly produce an updated prospectus. Google’s lawyers must have found it surreal that they were legally obligated to read Playboy for the articles.) This quiet period is basically designed to produce dozens of catastrophizing freakouts from the financial media, none of which the company can respond to.

When you put all of this together, the IPO process sounds less like an accomplishment and more like a fraternity hazing ritual. Yes, you can join Iota Pi Omega, but only if you submit to financial discomfort and a brutal roast.

Of course, the problems don’t end once a company is public. After the accounting scandals of the early 2000s, Congress enacted the Sarbanes-Oxley act, which substantially tightened up disclosure requirements, enforced arm’s-length relationships with auditors, and required managers to certify financial statements. Of course, it’s better for the world if fraud is spotted quickly and punished severely. The question is one of costs and benefits: Sarbox prevented some future Enrons and Worldcoms, but also prevented the next Microsoft or Oracle from going public until it was good and ready, that is, until the big money had been made.

Investing in companies with dubious accounting and flimsy disclosures is a risk, and markets are pretty good at ensuring that risk and reward are always correlated. Since Sarbox doesn’t apply to private companies, one reading of the rule was that you can only take a flyer on a risky company if you’re already quite well-off. It’s the white-collar version of the TSA: apparently effective at preventing what it’s supposed to prevent, but inconvenient and slightly humiliating for the vast majority of law-abiding people. (And, like the TSA, it has spawned exemptions available to the rich and savvy.)

Did Uber need to go public so they’d have actual cash rather than hypothetical wealth? Not really.

Coolness has an expiration date

The IPO was a cultural touchstone, but culture has a way of getting colonized by commerce. It’s odd to think of a financial ritual getting too commercialized and lame — it’s a bunch of people in suits trying to make money! Wasn’t it lame from the beginning!? But it happened nonetheless.

Perhaps what really happened was a confluence of media, culture, and regulation: the ’90s were not just a golden age for hot IPOs, but a golden age for financial media. The peak of CNBC, coupled with the rise of online business news, meant that more attention than ever before was devoted to market news. Anyone who has tried to produce financial news knows that it can get very boring, very fast: There are a lot of numbers, some of them went up, and some of them went down. The IPO provides a natural hook; a story good for filling space on a front page and time on a broadcast.

But this narrative fed on itself, and the IPO became too much of a big deal. It was the moment when average investors could buy in, and when early investors and employees could at least start counting down to when they could sell out. But at another level, it was just one more capital-raising transaction. A young company raises money until it has all the money it needs, and as it ages it starts returning capital instead. It’s good to look forward to big events, like graduation day, a wedding, or an IPO. But they’re just markers of progress, not progress itself; if you look forward to that event and ignore what comes after, you have a lot of growing up to do.

I write about technology (more logos than techne) and economics. Newsletter: https://diff.substack.com/

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