Is your company IPO ready?February 25, 2013: 11:06 AM ET
The three real keys to going public have nothing to do with $100 million in revenue.
By Glenn Solomon
FORTUNE -- As a junior banker at Goldman Sachs (GS) in the early 1990's, I was weaned on the conventional wisdom that growth companies were ready to go public when they reached $100 million in annualized revenue and had at least two quarters of profitability under their belts.
The "$100 million revenue" theory was based on the idea that a company must be large enough to both: (a) withstand competitive pressures and (b) earn a large enough market value to enable the company to sell enough stock to institutional buyers in its IPO, without suffering massive dilution in the process.
This theory makes no sense, despite the fact that many bankers and VCs still cling to it like religion. Growth-stage entrepreneurs who want to build long-term winners need to take heed. Going public is by no means the final step to going long. But, it's a big step in the process. Completing an IPO too early can have disastrous effects on the future health of your business. Conversely, waiting too long to do your IPO might allow a competitor to steal your thunder.
In my experience, there are three key attributes you must have to consider an IPO. You're taking major risks if you're not strong on these three:
1. Predictability & Visibility. If your business is $50 million in revenue but you know with high precision what next quarter, or even next year, is going to look like, you pass the test. On the other hand, even if your business is $200 million in revenue, and you can't reliably predict what's around the corner, watch out. Your VCs may have been happy when you hit 97% of plan last quarter. If you miss guidance or analyst expectations by 3% once you're public, your stock will likely plummet, often causing employee morale to suffer and competitors to be emboldened. The stakes are high -- take the time you need to ensure that you have built predictability into your company before your IPO.
2. Underlying Growth Potential. When CEOs fall into the trap of thinking the $100 million revenue plateau is sufficient to "get out" in an IPO, I like to ask them about their plan to get to $300 million or more in revenue. The IPO is not an end game. A better analogy is that going public is more like moving from college sports to the pros. You need to ratchet up your game and be ready. If you're growing fast and have a large market in front of you, $300 million or more will seem like a breeze, and public investors will reward you. If, on the other hand, you eke out growth to $100 million without much more potential and go IPO, don't expect to have a fun run as a public company. The best teams have several tricks up their sleeve for future growth. You may not know all the growth vectors you plan to open up in the future, but you should have a game plan before your IPO. The best teams are always investing in several experiments that could augment growth. You should be encouraged enough by the early results of such experiments before considering an IPO.
3. Vulnerability Assessment. The best companies have no single points of failure. Do you have a very large customer or two? A dominant supplier or distributor? A huge competitor? Or, are you beholden to a single platform, technology or regulatory regime? Any of these concentrations may be fine as you're building up your business privately, but once you're public, expect these facts to be scrutinized. Public investors hate this type of risk. They've been burned many times before. This shouldn't be unexpected – when another company realizes you rely upon them, they'll often extract a lot of value (e.g., Facebook (FB) and Zynga (ZNGA). Before considering an IPO, remove single points of failure. Even if this means growing more slowly for periods of time, the tradeoff will be worth it.
So there you have it, the "Big Three," an alternative set of requirements to the $100 million revenue milestones. If you nail these three, you won't just get to an IPO, you'll have a chance to go long as a public company.
Glenn Solomon (@glennsolomon) is a Partner with GGV Capital. Some of his recent investments include Pandora, Successfactors, Isilon, Square, Zendesk, Quinstreet and Nimble Storage. This post is part of a series for growth stage entrepreneurs who are thinking big; the full series can be found at www.goinglongblog.com.