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The IPO fallacy

The IPO fallacy

Don’t believe in the IPO fallacy

You did it. You chose the right startup, you got a good option package, and now you just have to wait for the IPO and you’ll be able to rake in millions. Or so it seems, anyway.

What is the IPO fallacy?

Although I don’t have the deep experience working with hundreds of startups like a long-tenured venture capitalist, I do have the immeasurably more personal experience of working at two highly successful startups and living through an IPO. What’s more, I’ve been working in the startup world for ten years now, so I have had the opportunity to meet and speak to people at hundreds of different companies.

The thing that’s been hard for me to learn personally -and one that I have noticed many others struggling with- is the IPO fallacy. What is it?

The IPO fallacy is the belief that an IPO will come, it will come soon, and it will make everyone in the company rich.

Working at a startup, it’s so easy to get wrapped up in the dogma and the good feelings. As you break milestones and sign new customers, and hire new people, it can seem like the company is truly unstoppable. “We brought on XYZ executive – he’s done it before so we’ll definitely meet our sales goals next year.” “We just signed a huge new account, there’s the quarterly number taken care of!” Or, even more common “We just got a new round of funding – we’re getting so much closer to an IPO.”

IPO’s are a rare beast

Unfortunately, the gleaming image of an IPO is largely a fallacy. As I am sure you are aware of, most startups actually never IPO. Most are bought long before they reach that phase, often at disappointing valuations with contingencies that ensure VC’s get paid instead of employees. Still other startups fail outright. Most common of all, companies will hobble along, slowly growing, but never reaching the terminal velocity they need to either IPO, or become an attractive target for acquisition.

Even if you reach the IPO, it may not work out well for employees

It isn’t just the rarity of an IPO that makes it into a fallacy. Companies can IPO and employees can still walk away with nothing. This can happen more ways than you might think.

  • Down-round IPO: Some companies, like Domo most recently, end up IPO’ing as a down round to ensure funding for the company and continue shuffling on. Because they are taking financing at a lower valuation than their last VC round, employees stand to benefit significantly less, and may even be the victims of liquidity preferences that ensure the companies investors walk away with their money.

  • Dip-before-the-blackout-ends: This is a particularly cruel way that employees can be screwed during an IPO. When a company IPO’s insiders and employees are required to hold onto their shares for at least six months to ensure a steady market for the stock that is sold in the IPO itself from being deluted by employee shares. But, if the company struggles or otherwise flounders during those first six months, the stock will drop and employees may be left with worthless options, or significantly devalued stock.

  • Brief moment of success: Some companies will make it past the blackout period, and may even appreciate significantly in that time period. That’s exactly what happened to me when I was at Tableau. We went from an IPO price of $30, to a stock price of $130 in less than a year. Unfortunately, it didn’t last long, as the stock dropped back down to $35 within a year on the back of difficult competition and the switch to subscription based revenue. You might be thinking to yourself “I would have sold at $130!” – and maybe you would have. But at the time, I was thinking that I would be crazy to miss out on further appreciation. Luckily, I sold enough to buy my condo and pay off my credit card debt, but I deeply regret not taking more money off of the table while I could.

How do you avoid the pitfalls of the IPO fallacy?

If you’re still with me up to this point, you’re probably wondering how you can avoid the pitfalls of the IPO fallacy, and ensure that you make the most of your stock options and the time you have at your company.

Take money off the table when you can

First of all, make sure to take money off of the table if you can. My current startup recently had a funding round, and they allowed tenured employees with vested stock to sell a small portion of their holdings. I sold the maximum amount. It was less than 10% of my total holdings, and I know from previous experience that there are no guarantees we make it to IPO (or that if we do it will be beneficial to me). There are also private market companies like Sharepost that will let you sell your shares in a private marketplace, assuming your company allows it. Keep in mind, every situation is different, so I cannot tell you if your specific situation merits a sale. But, for me, in my world, I am taking some cash (10-20% of my total shares) off the table when I have an opportunity.

Don’t forsake your other investments

Just because you have $2m in paper stock options doesn’t mean you have $2m. In fact, it’s about the furthest thing from it. Make sure to keep on investing in your 401k, setting money aside for your house down payment, building up your emergency fund, and generally acting like you are a responsible human being.

Keep hustling

Don’t count on your shares to make you a millionaire. You should be working on a side hustle, personal business idea, or consulting side-gig that will help you build your net worth in other ways. If you happen to get a bunch of money from an IPO, great. If not, great. You’re taken care of.

Don’t talk about it

Although this is generally good advice for anyone, don’t talk about your money. Keep your shares under your hat until you have the REAL dollars in the bank. Then, probably still keep it under your hat.

Stay positive, but don’t fall into the IPO fallacy

Now, you might be reading this and thinking that I am incredibly negative on my current company. I’m not. In fact, I truthfully believe that we are going to IPO, and I have strong reason to trust that it’ll be a good exit for me. But financially, I am acting like I don’t have a dime. I am saving, I am building my side hustle, and I am keeping my potential windfall under my hat.

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