From the Crowd

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Why go IPO in stormy seas?

August 22, 2011: 3:09 PM ET

Why companies keep going public in a choppy market.

By Jeff Richards, contributor

With last week's IPO by Chinese Internet video company Tudou (TUDO) and the previous week's IPO by Carbonite (CARB), quite a few people have asked me: "Why would a company go public in such a brutal market?"

It is indeed a very rough market. Extremely volatile. A lot of uncertainty around the world. Huge concerns about the US economy and a lack of any real progress on employment in the last few years. Investors are nervous. Nervous investors make for rough markets.

So why are companies still going public? And what about the companies that went public in the last few quarters and are now riding some very choppy seas (we've had 11 of our portfolio companies, including Tudou, complete public offerings since January 2010, and it's been a rough ride for many).

Here's the short answer: Going public is another mechanism for raising growth capital for a good companies.

A company puts significant growth capital on its balance sheet and is able to begin establishing a track record with public market investors. For existing shareholders and management who aren't selling any shares in the offering, the price of the offering is important (because they incur dilution), but not as important as where the company's stock is trading 12-36 months later. And, as my partner Glenn Solomon recently pointed out, the near-term price of an IPO has little to no correlation with where the stock trades in the future.

I remember when Rackspace (RAX) went public in August of 2008 (disclaimer: I have owned shares of Rackspace in my personal account for several years). There was no IPO market to speak of at all. Zip/zero/zilch. In fact, not a single venture-backed company had gone public the quarter before Rackspace began trading, and Rackspace ended up being the only venture-backed IPO within the 12-month period between March 2009 and March 2010.

RAX launched its IPO on August 7th, 2008, promptly "tanked" (Fortune's words, not mine), and kept going down from there (you may recall, we had one of the largest global financial crises in history that fall). As you can see from the chart below, it traded all the way down to $4.50:

But – the company put $187 million on its balance sheet for growth, and it was an emerging market leader with great business fundamentals. As you can see from the chart, RAX delivered for its shareholders quarter after quarter, eventually rising approximately 10X from its lows a mere 32 months later.

That's right – shareholders who bought RAX at the lows made an unbelievable return, and even those who bought at the IPO price of $12.50 made 3X+ on their money (if they held). RAX has traded down a bit in the past few months, but still sports a $4 billion market cap and is a recognized leader in the hosting and cloud computing industries. Its employees, management and early shareholders have been generously rewarded.

So – to answer the question: You go public in a choppy market because your business has strong fundamentals that investors will buy into regardless, you raise important growth capital, and begin establishing a track record as a public company.  Worry about the share price down the road. The market typically rewards companies for great performance over time, and management, employees and shareholders benefit.

Jeff Richards (@jrichlive) is a partner with venture capital firm GGV Capital.

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