×

Fixing the 'Brain Damage' Caused by the I.P.O. Process

"It seems like a way of living in hell without dying."

That was the way James Freeman, the founder of Blue Bottle Coffee, described the process of taking a company public in the modern era — and the way he explained why he sold his company instead to Nestlé last week.

It is no secret that the public stock markets — despite the heights they've reached (and the credit that President Trump has taken for them) — are fundamentally broken. No chief executive wants to live in the glare of the public spotlight and deal with pesky investors who hold stocks in time frames of days and months, not years and decades.

More from The New York Times:
Nestlé Targets High-End Coffee by Taking Majority Stake in Blue Bottle
In Flip-Flops and Jeans, An Unconventional Venture Capitalist
Whether Corporate Spying or Just a Spoof, Imitation Is a Dangerous Game

The number of companies listed on public stock exchanges is half what it was two decades ago. Last year, fewer companies went public than during the financial crisis.

Stewart Butterfield, co-founder of Slack and Flickr.
Mark Neuling | CNBC
Stewart Butterfield, co-founder of Slack and Flickr.

"It's a strange world. If it was 10 years ago, we'd be public by now," Stewart Butterfield, chief executive of Slack, an office messaging company worth $5.1 billion, told The Financial Times over the weekend.

Now, a series of entrepreneurs are emerging with some novel ways to fix the problem. Last week, Chamath Palihapitiya, a brash entrepreneur who was an early Facebook employee, launched a public company known as a special purpose acquisition company, or a "blank check" company, with $600 million put up by investors. The intent is to merge with one of Silicon Valley's unicorns, taking it public through a back door of sorts.

The idea is to remove "the process of going public that is true brain damage," Mr. Palihapitiya said.

At the same time, Spotify, the streaming music company worth some $13 billion, has been exploring a plan to list its shares on the New York Stock Exchange directly, without raising any new money from public investors.

Perhaps the most ambitious and provocative effort is a company that until now was in "stealth mode": LTSE (Long-Term Stock Exchange), led by the entrepreneur Eric Ries. Backed by a who's who of venture-capital investors — Marc Andreessen, Reid Hoffman and Steve Case among them — the new exchange aims to reimagine what it means to even be a public company. Among its changes to the ecosystem: the voting rights of investors (the longer you own, the more voting power you have), new disclosure policies (including a moratorium on "guidance") and a complete rewrite of compensation schemes so that executives truly focus on the long term (it recommends vesting stock over as long as a decade).

Before we go too far down the rabbit hole of how to fix the problem, it is worth understanding how the I.P.O. process — and the markets themselves — became so broken.

To hear Mr. Palihapitiya tell it, the shift — at least in Silicon Valley — began during the financial crisis, when he was working at Facebook. His candid explanation is surprising.

"We at Facebook basically flipped the narrative, and we did it on purpose," he said. "Our whole thing was 'Let's stay private longer.' And the reason we did that was we were pretty sure it would trick a lot of other people into not trying to go public or take advantage of the capital markets."

He said Facebook hoped that "all those companies would eventually die because they were not that good and we would suck up all of their talent."

Whether it was a trick or not, "stay private longer" became a mantra in Silicon Valley. And given all the cash sloshing around the technology industry, companies have been able to put off going public without going broke.

But it has created all sorts of problems, not least of which is that employees have felt that their social contract with companies — working for little salary but lots of stock on the assumption the companies would go public — has fallen apart. And it may very well be affecting innovation.

Chamath Palihapitiya
Getty Images
Chamath Palihapitiya

Mr. Palihapitiya said the lament of many employees had become this: "I can't pay for my house on 'mission and values.' I actually need current compensation. Silicon Valley is now one of the most expensive places to live." So many employees, he explained, have been hopscotching from one company to the next in search of an elusive I.P.O.

"Now you have these attrition rates of like 20-plus percent," he said. "How are you supposed to build an iconic legacy business when your entire employee base walks out the door every five years?"

Mr. Palihapitiya's answer is to eliminate the I.P.O. process and its year and a half of "distractions trying to craft a bogus narrative," as he described it, to entice investors. Instead, through his publicly traded vehicle, a unicorn company — shorthand for a $1 billion-plus private technology company — could reverse merge into it, instantly becoming public.

Unlike an initial public offering, in which employees and early investors all have certain "lockup" dates for when they can sell stock, he can write the rules however the company wants. Certain employees, for instance, could sell early, or the sales could be staggered so there isn't an "overhang" on the stock that would depress the price before a major lockup period expired.

Mr. Palihapitiya also was able to choose most of the company's big investors, who have agreed to their own lockups, making them much more oriented toward the long term. For all this, he takes a tidy fee: 20 percent of the $600 million. But if his company acquires a business five to 20 times its size through a reverse merger, he said, the fee is the same as or smaller than a banker's fee — and it is all in stock, so unlike the banks, Mr. Palihapitiya's interests are aligned with the company's.

But Mr. Palihapitiya's approach is just the tip of the iceberg. The most provocative plan floating around Silicon Valley is Mr. Ries's LTSE. "It's an intellectually thoughtful idea," Mr. Palihapitiya said.

The idea, at its core, is to change the dynamic between the stock exchange and whom it serves, Mr. Ries explained, suggesting that traditional stock exchanges focus more on investors — and all associated trading revenue — than on the companies listed. That, he believes, leads to short-term thinking and trading.

Mr. Ries, who wrote a book titled "The Lean Startup," is hoping to create an exchange that is focused on the needs of companies with a long-term vision and investors who are similarly aligned. He believes the problem facing private companies isn't just the I.P.O. process but also "the lived experience of being a public company."

Perhaps the most unusual part of his exchange's approach — which is still working to get approval from the Securities and Exchange Commission — is how much influence and voting power investors would have over companies.

Currently, an investor who owns one share for a month, or even a day, has the same voting power as someone who has owned a share for years. Mr. Ries wants what he calls "tourists" — short-term shareholders — to have less voting power than long-term shareholders, whom he calls "citizens of the republic." Over time, shareholders of companies on the LTSE would gain more votes based on their length of ownership.

Such a system might make dual-class structures, like at Snap (or The New York Times) less attractive to its founders. That would also help end another problem that has emerged: Dual-class companies pay the chief executive, on average, three times as much as companies with a single share class.

Mr. Ries also takes aim at compensation plans. He wants companies that list on his exchange to have stock vesting programs of at least five years and recommends 10 years, even for executives who leave the company.

Now, this may be very hard to put into practice, and it's tough to know whether it would work. "It's very difficult," Mr. Palihapitiya said. "Ours is not as intellectually ambitious." But all of these efforts are meaningful attempts to fix the system. Even if they don't work as advertised, hopefully the establishment will take notes.