
In defense of the IPO, and how to improve it - naftaliharris
https://a16z.com/2020/08/28/in-defense-of-the-ipo/
======
Ericson2314
Excellent breakdown with the proper theory. However

> In an institutional fundraise, all buyers must get the same price

Isn't that the basic problem? Don't we have tons of auction theory on how to
_not_ sell all at the same price? presumably that auction theory also properly
doesn't confused the varying unit price vs total money raised (it's integral).

~~~
TooSmugToFail
I believe this is partly due to long term relationships aspect of the IPO
process.

During roadshows, underwriters are essentially leveraging their rolodexes.
These relationships constitute a significant part of the value they are
bringing to the table.

If there would be a different price for each investor, some would get a better
price than others, and those that got a worse price would not feel very good
about it, likely deeming it unfair (there are still people behind the
processes, and people can't help but experience emotions of fairness and a
lack thereof).

As a result, relationships would likely suffer due to this human aspect to it,
and weirdly enough, these grudges can easily get absorbed in the
'institutional memory' and linger there long after the original human
protagonists have left the organisation.

A way to address this, would be to introduce rules like first-come-first
served, which would imply giving up a degree of control by underwriters and
the company. This, however, introduces risk for the company which, after all
needs that control in order to maximise value.

It's not a simple problem to solve, but maybe there is a better solution
somewhere out there...

~~~
vlovich123
If they want the most accurate price (doesn’t move much from the initial IPO)
a blind second price bidding strategy is useful.

If the company wants the highest price they would do an auction of
successively increasing lot sizes.

However, the pool of investors for something like this is small enough that
you’d be trying to fight out-of-band collusion. Similarly the underwriters
don’t want you to have the highest price. They want the investors to get a
price better than the stock is actually worth so that they continue to show up
to deals the underwriters organize.

I too think there must be a better way but I suspect you may need some
regulation and enforcement of this market to actually see it through.

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actuator
Interesting points they are making, it would be interesting to see how much of
the IPO volume gets sold out in the first week or month to see how much of the
price is being driven by just a few shares.

I looked at Zoom's IPO, the trade volume on IPO day was around 26M with
closing price of 62. If for simplicity we disregard the same shares being
traded(trading strategies, HFT trades). This is about $1.5 B in volume, they
raised $0.36 B in IPO. So, the point that the article makes about the value
being driven by just a small set of "gamblers" and not the value of the
whole/majority of IPO block probably needs to be looked at with data.

Is there any way to determine the big institutional trades on a particular day
to see if any of the IPO subscribers ended up selling in the first few days of
listing?

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satya71
I've read countless articles on IPOs. This is the first time I appreciated the
mechanics and economics. Excellent article.

------
dperfect
This makes sense from an investor’s perspective. My objection to IPOs is not
so much financial, but more about what it does to a company’s internal
culture. Having been at a company that went through an IPO, I saw how that
culture shifted - almost overnight. You had employees that once cared about
doing their best at their jobs to ones that focused only on how their
contributions would affect the public stock performance (which can overlap,
but often doesn’t). Every time the stock price took a (short-term) hit,
employee morale suffered. It was as if a large LED stock ticker were installed
on every desk, constantly reminding employees that _this_ is the new key
indicator that matters above all. It was obvious even among upper management;
discussion went from big picture, somewhat ambitious ideas to short-term
thinking, centered on how to show good numbers in the next quarter with
obvious, incremental adjustments (like pushing more ads rather than developing
more interesting products and features).

The funny thing is, the company didn’t actually _need_ the funds raised in the
IPO. They had an almost endless supply of interested private investors pouring
in money regularly, and the company’s CEO (in private) admitted that they
never wanted to do an IPO. It was only necessary in order to appease the
expectations of early employees who had been promised a big payday for the
shares they were offered instead of competitive salaries. I understand why
that was done in the company’s early days, but there ought to be a better way
to reward/incentivize early employees that doesn’t rely on the fickle and
myopic nature of publicly-traded stock.

~~~
vkou
> I understand why that was done in the company’s early days, but there ought
> to be a better way to reward/incentivize early employees that doesn’t rely
> on the fickle and myopic nature of publicly-traded stock.

The IPO is the carrot that you're dangling ahead of early employees many years
prior to getting to that point.

When you've gotten to a state when you're ready for an IPO, they are expecting
to _actually get_ that carrot. You have no leverage or new incentives that you
can give to an early employee after you IPO. If they are sticking around
after, you're either drowning them in money, or they are doing it as a
courtesy.

So, your alternatives are to ask them nicely, or give them a boatload more
money to stick around.

> They had an almost endless supply of interested private investors pouring in
> money regularly

It sounds like they were interested in pouring money in to grow the business,
not to reward early employees. (Which is perfectly reasonable.)

This is why you're finding the two things at odds with eachother. As an
employee in a pre-IPO company you have a much smaller small amount of leverage
for any sweat equity you put in, compared to someone who paid real dollars for
their equity. Your interests aren't aligned with your investors, and their
interests aren't really aligned with yours, outside of one thing - you both
want to get to a point where you can cash out, via IPO.

~~~
dperfect
> The IPO is the carrot that you're dangling ahead of early employees many
> years prior to getting to that point.

Yes, that's essentially what I'm saying, but I wonder if there aren't some
better alternatives to incentivize early employees when cash is scarce. Maybe
(just off the top of my head) something like a contract to pay the employee a
set dollar amount (with interest) at an undetermined point in the future, and
it must be paid _before_ any profits can be distributed to owners (there could
be other triggers as well). This would be in addition to the employee's
salary, which is likely to be at below-market levels when the company is still
young.

It could come with additional features similar to a vesting schedule, but
essentially it would (1) give the employee a _known_ dollar amount of
compensation contingent on the company's future success, (2) allow the company
to remain private (if desired) while still delivering the "carrot", (3) avoid
the need for an option pool, and (4) avoid the issues I described in my
earlier comment. After some or all of that amount is paid to an employee, the
difficulty in keeping the employee around is no different, but at that point
(where profitability allows for the payout), a company is more likely be in a
position to offer/renegotiate competitive salaries in the first place.

Then again, a lot of founders/owners probably don't want something so concrete
because _of course_ they benefit from being able to attract talented people at
a discount by offering a tiny bit of equity and the dream of becoming a
millionaire when the company IPOs or gets acquired. Heck, I've been there - on
both sides of the conversation. But the truth is, a lot of people are
realizing that equity isn't usually worth what a founder thinks it is, so
that's becoming a less effective bargaining chip as time goes on.

~~~
vkou
Hollywood does this sort of thing. It's a complete and utter scam.

Films that bring in hundreds of millions of dollars from the box office
_consistently_ manage to post up zero-dollar profits. (Screwing anyone who
lacks the leverage to have demanded a percentage of revenue, as opposed to a
percentage of profits.)

And yet, somehow, the funders keep bankrolling 'profitless' sequels after
sequels.

As bad as the 1/9/90 split of outcomes for startups is for employees (1% of a
good exit, 9% of slight profit/break-even, 90% of a loss), transitioning to
your model will destroy the upshot of the 1%, and make the 9% even more
contingent on your employer and funders not engaging in Hollywood accounting.

What you propose creates a colossal incentives for investors to turn the 9%
case into an (on paper) 90% case - because otherwise, they'd be on the hook
for a very large number of backdated salaries - the obligations for whom
magically disappear if you structure the 9% case as a profitless exit.

~~~
dperfect
I'm familiar with how residuals work (and sometimes go unpaid), but in my
opinion that's not a flaw in the idea itself, but rather a question of
regulation and/or better legal work (in the contracts) to prevent studios from
exploiting loopholes.

Earlier in my career, I was the victim of similar shenanigans when it came to
startup equity (promises of equity that never materialized), so it's not like
the traditional path to IPO precludes deception and exploitation. My point is,
with proper legal boundaries, a system of compensation with _increased
transparency_ is fairer than the current one that essentially uses a startup
lottery to attract employees.

------
fossuser
The counter argument in favor of direct listing:
[https://podcasts.apple.com/us/podcast/invest-like-the-
best/i...](https://podcasts.apple.com/us/podcast/invest-like-the-
best/id1154105909?i=1000451016956)

I’m not sure anyone is arguing SPACs are a better idea for the private
company?

SPACs can offer some certainty in what may be an uncertain market, but their
entire point is that the SPAC creator is selling this certainty by finding an
undervalued company they can take over on the cheap. I think a SPAC is a
really bad way to go public unless you’re someone like Nikola where your
company is basically a fraud ripping off the SPAC, in that case probably a
good way to go for the founder.

I’m still skeptical of the a16z arguments defending the IPO pop. When you have
banks doing lots of transactions and founders doing only one or two the
transactions will likely be skewed to benefit the banks along with a really
compelling narrative of why they’re not.

The simpler answer seems more likely here, I think Matt Levine is probably
more correct.

[https://www.bloomberg.com/opinion/articles/2020-08-06/it-
s-a...](https://www.bloomberg.com/opinion/articles/2020-08-06/it-s-a-good-and-
bad-time-for-ipos)

~~~
bobbylcraig
I've always been confused by DPOs. Isn't it essentially a money-grab by
initial investors waiting to cash out if you don't need the capital infused by
the IPO?

~~~
fossuser
It gives liquidity to employees as well as initial investors and it gives the
public the ability to buy shares.

------
fadesibert
Excellent article - goes into some detail on the myth of oversubscription
(well, inflation of reality)

------
rebase-vc
the much bigger problem than pricing is timing. retail investors don't get a
chance to buy in until the company is already valued at $1-$10B because
institutional investors hoard all of those gains.

the other issue is VCs using public markets as a dumping grounds for shi... I
mean not so great companies like blue apron or lendingclub, and leaving retail
holding the bag.

software is eating the world and capitalism is eating itself. i say this as
someone that has benefited from software and capitalism but also knows that
the system is extremely flawed

------
joschmo
This is a breath of fresh air in comparison to HN's typical ignorance on IPOs.
I can see why it wouldn't be popular here.

A mix of the theoretical grounding of the activity with the on-the-ground
realities of filling up a book and mechanics of how it happens. The IPO isn't
perfect, and is in need of a software-defined overhaul, but does have clear
value. We'll see if Carta's Xchange product can live up those goals.

~~~
dang
Please don't sneer at others in HN comments, including putting down the rest
of the community. Believe me, I understand how annoying widespread ignorance
can be, but the only thing that has a chance at helping is patient
explanation. Adding more poison only makes things worse.

If you know more, the thing to do is to share some of what you know, so the
rest of us can learn. You've done this in previous comments, which is great.

[https://news.ycombinator.com/newsguidelines.html](https://news.ycombinator.com/newsguidelines.html)

