Are IPOs Broken?

Hey y’all — bad news. The IPO model might be broken.

One of the most anticipated IPOs of the year happened this past week when Figma finally reached liquidity after their acquisition by Adobe was effectively blocked due to regulatory concerns.

Their founder, Dylan Field? Now a billionaire (though he sold very little stock).

Major investors? 10x’d their funds with a single company.

You might be thinking… “what could possibly be the issue?”

Keep reading and I’ll tell you…

Are IPOs Broken?

First — why do startups IPO?

Some people say visibility and credibility but, while that may have been true in the pre-internet era, it’s not a major factor anymore.

No, the reason startups IPO is to get a financial return on the blood, sweat, tears, and VC cash that’s powered the company so far (and raise some new money for the company itself, too).

It’s to turn what was once a risky investment into cold hard cash.

It’s purely a financial thing.

This, of course, is very valuable and makes complete sense — after years of hard work, people deserve an outsized payoff.

And this isn’t easy or free.

Once the IPO happens the founders now have new responsibilities around financial transparency that weaken the company’s competitive position, require time and money to put together with accuracy, and invite scrutiny.

But first, to have a successful IPO, founders need to go on a roadshow where they essentially pitch the stock to “institutional buyers” who can purchase large volumes of shares and get first crack at buying the stock before it is offered to the public.

This is where it starts to break down.

IPOs have two prices: one for the institutional buyers and another for everyone else.

A combination of newly created shares and existing shares from the founders and VCs are offered to the institutional buyers at the IPO price.

Then, later, the floodgates are opened and retail investors can try to buy the stock.

More interest from both cohorts = a bigger “pop” and a higher opening price.

In the past, a big pop was good. It helped with sentiment around the stock. But these days it’s less important. The real beneficiaries of the pop are the institutional buyers while founders leave money on the table.

Figma’s IPO price last week was $33 per share, which valued the company at $19.3 billion.

That seems like a great outcome and, of course, it is.

But the opening price was $85 per share due to extreme interest, meaning that everyone who sold shares at the IPO price ($33) actually made less than the institutional buyers who bought at $33 but then saw the price skyrocket to $85 did.

That’s just crazy.

Who really deserves to make the most from Figma’s IPO? These buyers who got the chance to invest because they had a good relationship with the underwriter? Or, well, Figma?

Not to mention the new shares issued by the company as part of the IPO could have raised more than 2x the capital for the company itself.

It’s no surprise that startups have explored alternative methods of going public like SPACs and direct listings in recent years.

It’s also why we’re seeing Augment and other platforms offering shares in still-private startups to the public.

There’s massive retail investor interest in late stage startups that are increasingly resisting going public for as long as possible (and instead raising more private capital). And yet they’ve historically been gate-kept by this IPO process and its insider buys that make the market less efficient.

And supporting pre-IPO private market sales is actually good for startups too since they can get a sense of what price retail investors are willing to pay, which can lead to more accurate IPO prices (and less money left on the table).

This article goes into the technical breakdown in a bit more detail, but the big takeaway for founders here is that as your startup grows and you start thinking seriously about liquidity, consider allowing private market trading.

It’s just good stewardship — you win, your investors win, and your company wins too.

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