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Stanford GSB News

 

The Risky Business of Going Public

March, 2003

STANFORD GRADUATE SCHOOL OF BUSINESS—The process of going public in a post-Internet-bubble world has become more of a roller coaster ride than ever. Complicating the already hard job of finding backing, distrust of corporate leadership in the wake of Enron has created a call for even more regulation and oversight, and added a heavy burden for young firms.

Academics, venture capitalists, and policy makers recently gathered for a two-day Joint Conference on Entrepreneurial Finance and Initial Public Offerings to assess the present state of investments in new ventures and the IPO process. Sponsored by the New York Stock Exchange and by Stanford Business School's Center for Electronic Business and Commerce (CEBC) and Center for Entrepreneurial Studies (CES), the conference invited participants to discuss what new practices will begin to emerge as the market recovers, and how technology can be used to improve the capital formation and allocation process.

"One of the reasons for the Internet bubble was overreaction—first to what appeared to be good news that created a cycle of hype, then to the hangover that followed," said Haim Mendelson, codirector of the CEBC. "Just as investors and entrepreneurs should focus on the long run, so should regulators. Regulatory overreaction can be extremely harmful given the current state of the capital markets. Subjecting new issuers to suspicion and unreasonable scrutiny would not give investors back the money they had lost in the past. It would only make it more difficult to obtain liquidity, increase the hurdle rates for new investments, and impede innovation, new capital formation, and growth. So I think the message is that regulators need to be open-minded and reasonable rather than overreact."

Conference participants heard the travails of going public from two CEOs who recently weathered the storm—Peter Thiel, former CEO of PayPal, and David Langstaff, president and CEO of Veridian. Thiel described the particularly mercurial odyssey of PayPal, an email-based payment service that currently serves more than 20 million users, as it raced to go public in February 2002. Not mincing words, he said, "Going public today is a process I wouldn't wish upon my worst enemy."

In early September 2001, after an ill-fated day spent with one investment bank in an attempt to solicit an underwriting agreement, Thiel and his team decided in the taxi ride back to the airport to hire a different bank and consoled themselves with the thought, "Tomorrow will surely be a better day." That, he noted wryly, was September 10, 2001.

PayPal persisted in its effort to go public soon after 9/11, Thiel recounted, "despite the fact that people thought we were crazy." Compounding the queasy financial atmosphere was the explosion several months later of the Enron scandal, which thrust regulators into a mode of hyperscrutiny regarding companies aiming for the public limelight. "Their examiners put us under an electron microscope," Thiel said. Critical media attention and the threat of several lawsuits against PayPal for alleged patent violations continued to plague the company until it at last crossed the finish line with its IPO on February 14, 2002.

Moving out of the private sphere was ultimately advantageous to PayPal, he said. On the day of the IPO, the stock increased by 55 percent and stayed at high levels despite the fact that the NASDAQ was not doing well. Moreover, going public eventually facilitated the acquisition of the company last October by eBay for $1.5 billion.

However, Thiel expressed reservations about the way the IPO process is currently conducted. "It has become too difficult for companies to go public," he concluded. "While there was probably too much trust three to four years ago, now the pendulum has swung too far in the opposite direction. I think that as a result, we're going to see significantly fewer private firms issuing IPOs."

David Langstaff had been building Veridian in various capacities for 19 years prior to its IPO in June 2002. His firm was able to succeed despite the "environment of crisis regarding public confidence in corporate leadership" that now is typically part of the IPO process.

Langstaff said his company's transition began with careful consideration as to whether moving out of the private arena was wise from more than just a financial standpoint. "As CEO," he explained, "I had to pose the question: Would going public reinforce the company's culture? If not, I knew that it would in time destroy us."

To be sure that the "Veridian way," which stresses integrity, responsibility, and the primacy of customer service, would be enhanced, Langstaff sought investors interested not in quick profit but in sustainable, long-term value. "It's very important that there be alignment between your company's goals and your investors' expectations about your financial performance and the time frame they are looking at," he said.

Getting the right analysts on board was even more critical to Langstaff than choosing the right investment bank. "The bank would come and go," he said, but analysts would be there to follow the company in the long run.

Like Thiel, Langstaff also expressed worry about the current state of IPOs. "Going public is very expensive; I don't know how smaller companies can afford it. I also wonder how firms can be expected to act in the interests of building long-term sustainability if investors are holding stocks in investment portfolios for less than 11 months, on average."

The Conference on Entrepreneurial Finance and Initial Public Offerings was held at Half Moon Bay, California, March 6-8. For more information about the program, see www.gsb.stanford.edu/cebc/.

—by Marguerite Rigoglioso