The recent IPO of the UK company King Digital Entertainment, which made its name from the popular online game Candy Crush Saga, demonstrated why acquisitions are becoming a much more attractive proposition as opposed to a public offering. An exit strategy orchestrated by an experienced and skilled corporate finance boutique can hold multiple advantages over a grandiose but frequently underperforming IPO.
Despite King’s bankers scrambling to persuade investors in the run-up to the IPO that the company can develop more successful titles like Candy Crush Saga, few believed the hype. As a result, the firm priced the offering at the mid-point levels of $21 to $24. However, its shares declined rapidly in last week’s debut, falling 16.0% on the day of release and further in the following days. In part, this is because investors are beginning to look at IPOs as a weak platform for unprofitable business. Out of 50 IPOs priced in 2014, around two-thirds are unprofitable, according to Renaissance Capital. For businesses that are based on potential value and future progress, an acquisition makes more sense than an IPO.
Why an IPO is a risky proposition compared to an acquisition
Here are some reasons behind an IPO’s decreasing attraction:
- Going public is an expensive process. Typical IPO costs for start-ups range from $250,000 to $1 million, even if the offering does not go through
- Too much focus on the short term from public shareholders, who want rapid results. Pressure to increase current earnings, and little appetite for strategic investments
- Start-ups going public are vulnerable to mainstream competitors and critics, since they are forced to disclose internal workings
- All public companies are always at risk for takeovers, whether friendly or hostile. This could lead to company founders losing control of their own strategy
- Public company executives and directors are at civil and criminal risk for false or misleading statements in the registration process, which translates to increased liability risk exposure
- Strong market swings typically hit public companies first. Private companies in less-relevant market segments can fly under the radar during economic crises and recessionary periods
And more companies are taking heed of such risks and challenges. According to an Ernst & Young report, the number of start-ups that have gone public in the US over the past 10 years is down by 75% on the previous decade. In today’s climate, eight times as many successful start-ups are acquired compared to the number looking to go public.
Increasingly, while companies looking to acquire start-ups are often pricing their target at future potential and not explicitly at present profitability, the opposite is true in the IPO market. Tech companies are especially less suited to an IPO, as they more often represent a future growth model as opposed to an actual value story. Turning to a sell business for an exit strategy or capitalisation is becoming a more sensible route for a tech start-up than the risky IPO alternative.
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