
Fixing the ‘Brain Damage’ Caused by the I.P.O. Process - KKKKkkkk1
https://www.nytimes.com/2017/09/18/business/dealbook/ipo-chamath-palihapitiya.html
======
mbesto
Good analysis from Matt Levine on how Social Capital Hedosophia Holdings Corp
(SPAC trying to eliminate the headache of IPOs) is actually more expensive
than going public.

> _A final thing about SPACs is that they are so expensive. Banks charge a
> rack rate of about 7 percent for initial public offerings, though big sexy
> tech IPOs tend to be done more cheaply. SPAC sponsors compensate themselves
> rather more lavishly. Hedosophia 's sponsor -- a Cayman Islands company
> owned by Palihapitiya and his co-founder -- invested $25,000 to found the
> SPAC. In exchange for that nominal payment, and their work on finding a
> company to take public, they get 20 percent of the SPAC's stock. (They are
> also are putting in another $12 million or so to buy warrants in connection
> with its IPO.) A 20 percent fee for taking a company public is just ... more
> ... than a 7 percent fee. And that's not even counting the 5.5 percent fee
> that Credit Suisse charged for taking Hedosophia public! Something like a
> quarter of every dollar that investors are putting into Hedosophia is going
> to compensate financiers for doing the work of (ultimately) taking a unicorn
> public, which is a funny way to make that process more efficient._

[https://www.bloomberg.com/view/articles/2017-09-15/icos-
vcs-...](https://www.bloomberg.com/view/articles/2017-09-15/icos-vcs-ipos-and-
spacs)

~~~
whack
I was confused by Hedosophia's value proposition after reading that earlier
article as well, but NYTimes seems to do a better job of explaining it.

> " _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._ "

Ie, the banks charge 7% of the startup's IPO valuation, whereas Hedosophia's
sponsors charge a flat 20% of the $600M, regardless of the valuation of the
startup it buys. According to the above math, if Hedosophia reverse-merges
with a $3B unicorn, the effective fee would only be 4%.

~~~
twinkletwinkle
That's not correct. The bankers' fee is 7% of the money raised in the IPO, not
of their total valuation.

Matt Levine addressed that one too:
[https://www.bloomberg.com/view/articles/2017-09-19/memory-
mo...](https://www.bloomberg.com/view/articles/2017-09-19/memory-mortgages-
and-puzzles) Can't see how to link into the article but if you ctrl-f
Hedosophia you'll see his point.

~~~
whack
Thanks for the link. I'll admit that I'm not an expert in IPO-finance, and I'm
surprised that Andrew Ross Sorkin and Matt Levine are saying such
diametrically opposing things. There's probably some nuance to their
disagreement that I'm missing.

------
warcher
I feel like.... maybe some of these guys are feeling the hangover from other
people's money, and trying to have it both ways.

It's far from easy to bootstrap, but you basically solve all the problems
these guys are talking about if you can survive it. The problem, of course, is
that your unit economics have to work, you have to have the personal patience
and resources to get to profitability, and you have to survive a potential
funded competitor using their financial leverage to sell at or near a loss and
torch your position in the market.

So a lot of folks take the money, but you take the money, you gotta pay it
back. An IPO is ultimately just kicking the can down the road, and taking on a
new set of guys that are going to cash out your venture debt for public debt.
Who also expect to be paid back. I don't see a way out of this devil's bargain
short of, you know, delivering on the milestones you talked about in your
pitch deck, or in your roadshow.

But spare me the crocodile tears, huh? You took the money, you gotta pay back
the money. Plus interest. And a lot of these IPOs, they had to make big
promises when they went public-- big multiples, big projections, to support
big valuations. Now you are sitting on a big pile of teachers' pension money
and you have to deliver.

------
jshaqaw
Ask any of these CEOs if it would be cool to hear from there direct reports
once a year or once a decade. This is just a whining plea for no
accountability from managers. The right to execute a long term vision has to
be earned by effective communication and superior execution. Just look at
Amazon. No quarterly profits and it is the darling of a Wall Street. You don’t
get to flounder around without a clear strategy or results and then complain
people want to know every 90 days where things stand.

~~~
sulam
Amazon is exceptional. Emulating Amazon will get most companies delisted.

~~~
hellbanner
Can you describe more about what practices would cause delisting?

~~~
piker
Running out of money by only spending on R&D and having your share price drop
below listing thresholds, I think, is the implication.

~~~
sulam
Yeah, I don't think you'd even have to run out of money. There are plenty of
companies generating a fair amount of cash flow that hover in the dangerous
territory of < $3 a share. It only takes one bad quarter.

Here's an example of a company that generates cash but only recently is in the
safe-ish territory:

[https://finance.google.com/finance?q=LLNW](https://finance.google.com/finance?q=LLNW)

(Not that I think they are emulating Amazon, mind you, just making the point
that you can have a going concern, and still get delisted.)

More broadly, unless you have an amazing business, you probably shouldn't
emulate Amazon (or Google, or FB, or any other business that is depending on
free cash flow to fund R&D as opposed to generating profits).

~~~
goialoq
> the dangerous territory of < $3 a share.

that's only dangerous until the stock does a reverse split.

------
mathattack
Here's my problem with the Long Term Stock Exchange idea...

What makes the tech echosystem thrive is the flexible capital and labor model.
Anyone can get a little money to chase their idea. The small ideas get starved
for capital and labor until they get market validation. Then the capital and
labor chases them. And that's how great companies grow so quickly in a land of
startups.

Anything that restricts mobility of labor hinders this and should be fought.
(Example: Non-competes, cost-prohibitive real estate, etc)

Anything that restricts mobility of capital should be fought too. To have
capital available for great ideas, it should be easy to flee ideas that aren't
working out. (This is also why share buybacks from mature companies are fine -
the capital get recycled)

~~~
dasil003
I agree with you in principle. The problem is that status quo encourages very
short term thinking that has caused a lot of damage. I think it's at least
worth toying around with longer-term incentives to see what can come out of
it. I'm not super excited about 5 or 10 year vests (especially 20 years into
my tech career without an FU nest egg), but it's a far lesser evil than non-
competes or astronomical real estate (the latter being the thing that will
likely drive me away for the sake of my family).

~~~
mathattack
I'm not sure I follow you on real estate. Does the OP's proposal for long term
capital fix that? Best I can tell, the one thing that will fix expensive real
estate is autonomous cars. (Parking can be converted to housing, and longer
commutes become tolerable)

~~~
dasil003
Actually I was just reflecting your examples, not citing things which the
proposal would fix.

~~~
mathattack
ah - got it. Unfortunately expensive real estate is a 2nd order effect of
flexible labor and capital.

------
valuearb
"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."

This is really a poorly thought out idea that's hugely counter-productive. You
own your shares for 10 years and have mucho voting rights, but need to sell
them. Now you have to sell them to someone who will get virtually no voting
rights at the time of purchase. So all this does is make your shares way less
valuable. It will end up creating "phantom sale" markets where you continue to
serve as the shareholder of record, but agree to vote your mucho votes the way
the purchaser wants you to.

The real problem isn't short term holders. The real problem is that
shareholders aren't owners. The SEC won't let shareholders pick the boards of
their own companies. Companies are owned by their managers now, and they are
the short term thinkers using their incentive stock options to drive their
decisions.

------
bedhead
My prediction is that Chamath will use this SPAC to purchase Social Capital's
VC investments. The conflict of interests are simply too great and I've seen
this stuff before - it's almost always by design.

~~~
sjg007
Makes sense. A payout on a payout.

------
neilwilson
Or perhaps we can drop the insane valuations of service companies whose value
is in their staff not their assets, just pay people properly in the first
place and have companies go back to earning profit and paying dividends to
investors.

Or is that too rad for Silicon Valley?

I know that we're all supposed to live off pension funds, but the idea is that
is after retirement not before through selling over inflated stock to them.

~~~
tomcam
> we can drop the insane valuations of service companies

Awesome! But... how?

------
mikikian
Color me skeptical and maybe one of the attorneys on HN could jump in, but
solving the brain damage of an IPO reason seems like a red herring to me. SPAC
could have value in a down market, when the IPO market is closed and a company
is forced to raise a down round. Ratchets would kick in and founders would
lose equity. If the SPAC, after fees, is able to offer a higher valuation to
the company then its best alternative, it might actually work to benefit the
company.

I haven't seen anyone comment about this down market scenario this past week
and wondering if someone smarter than me had any thoughts?

------
throwaway2048
Why are reverse mergers not more popular? Seems like there is quite an opening
for somebody to spin up assetless shell companies, take them public and then
sell them off the private companies that want to go public, and denying market
makers and underwriters their huge rake, and sidestep most of the other issues
surrounding an IPO.

------
lifeisstillgood
Want long term investors in your company - why not offer extra voting rights
after specified periods of holding registered shares - one year one vote, 10
years 5 votes.

There are many things companies can do to encourage long term, stockholder
engagement - starting a random new stock exchange seems to be a long way down
the list

------
kecoco0207
Other solutions are currently in place to solve the IPO and liquidity problem.
EquityZen is a platform that lets employees sell shares before IPO:

[https://equityzen.com/?utm_source=news.ycombinator.com%2Fite...](https://equityzen.com/?utm_source=news.ycombinator.com%2Fitem%3Fid%3D15284893&utm_medium=Hacker%20News&utm_campaign=Hacker_News&utm_term=news)

------
brndnmtthws
The ICO funding model seems much better: complete transparency, a truly free
market, it's very difficult to manipulate the currency (i.e., magically
issuing new coins aka share dilution), and it's easy to get around the
stupidity of the US gov by incorporating somewhere with more liberal laws
like, say, Switzerland.

Why would you want to business by the rules in the US when the rules only
exist to prop up rent seekers and the ruling elite?

~~~
hellbanner
The SEC introduced "accredited investors" in the USA because scammers were
taking money from people who didn't/couldn't research scams and lost fortunes
in get-rich-quick stock schemes.

~~~
brndnmtthws
That's the story they (the SEC and friends) provide, but to me it seems more
like they wanted to make it hard for people with limited means participate in
the legalized get-rich-quick schemes.

How about just let the market decide? Why do we have stupid rules that exclude
poor people from investing?

~~~
blawson
Because when those poor people make one bad choice they lose everything, and
the state has to take care of them.

~~~
brndnmtthws
Yeah, just like the government bailouts during the 2008 financial crisis[1].
Except the US gov doesn't bail out poor people.

[1]:
[https://en.wikipedia.org/wiki/Financial_crisis_of_2007%E2%80...](https://en.wikipedia.org/wiki/Financial_crisis_of_2007%E2%80%932008#Government_responses)

~~~
ericd
If the government hadn't done that, there was a very real chance of the
economy grinding to a halt, with mass layoffs resulting, which would have had
a very, very large impact on poor people. So yes, in a way, it was a bailout
of poor people.

I think they should have done much more to break up the banks into smaller
chunks in the aftermath, but I'm tired of this sort of lazy condemnation of
what they did as some conspiracy to help rich people and not poor. They were
trying to get the country through some very dire times.

