Musings on Entrepreneurship and Innovation
Friday, September 17, 2004
Dutch Auctions and Straw Men
Talk about Google's "Dutch Auction" IPO annoys venture capitalist Bill Burnham. For starters, he wrote recently, "no matter how you look at it, Google's IPO was clearly not a Dutch Auction." But Bill's criticism runs deeper:
However things evolve, the mindless championing of Dutch Auctions and "democratic" allocations is not doing anything to improve the IPO process. Rather it is simply lulling issuers into believing that the only thing that matters about an IPO is getting the highest price possible. Getting a high price is important, but it's also important to get a stable core of long-term shareholders and to avoid allocating shares to flippers that might needlessly destabilize a stock's trading early on. Issuers and underwriters have to balance both of these needs and as [a] result retaining the flexibility to allocate shares remains incredibly important no matter what the academics say.
Let me concede right now that it's very likely that Bill knows a great deal more about IPOs and Dutch Auctions than me. Notwithstanding the potential merits of his assertions, however, it strikes me that he may be protesting too much. When he implies that "academics" are mindlessly championing democratic IPO stock allocations, I infer a straw man fallacy. When the straw man appears, I start to wonder whose ox risks being gored?
Institutional fund managers, investment bankers, and professional venture capitalists all have a vested stake in their roles in intermediating the transition between being a private company and becoming a public company. The IPO process can seem Byzantine to the uninitiated. The guidance provided by a VC who has walked the path many times can be valuable, indeed. It seems plausible to me that any process that commoditizes the IPO process would commoditize the roles of intermediaries.
I can imagine scenarios in which a VC would be concerned about volatile trading in the early days of a company's life. As a group, VCs tend to view themselves as private company investors. In general, I suspect, they are motivated to distribute their publicly traded shares to their institutional limited partners (who, after all, tend to be in the business of managing portfolios of marketable securities) sooner rather than later. In a volatile trading environment, however, distribution timing becomes important because it typically triggers a valuation event for purposes of calculating the general partners' carried interest compensation. If the price jumps after a distribution, the GPs could have left millions of dollars on the table. If the price tanks subsequent to a distribution, the LPs might feel that they've been taken. Volatility can be a royal pain for VCs, but is not necessarily bad for everyone. After all, employees who hold options on company stock benefit from increased volatility because they are shielded from downside and benefit from upside.
In the end, though, I share much of Burnham's skepticism. To the extent that Google's IPO has been trumpeted as the bellwether of a new age of democratic capitalism, the claim seems overblown. According to Colin Wallace at Publex Ventures, there are some 10,000 public companies in the U.S., and over half can be classified as small-cap or micro-cap "orphans" that don't benefit from a liquid market. That is, they have the obligations of being public but don't have effective access to the public capital markets. If there was an under-supply of public companies, the cries for the dis-intermediation of the IPO process would be persuasive. But, Wallace's data suggests that, if anything, there might be an over-supply of public companies.
But, I speculate well beyond the bounds of my knowledge and experience. In the meantime, I'll continue to advise high-growth companies with IPO aspirations to consider engaging with a competent VC firm in order to prepare for and navigate the IPO.