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The Role of Venture Capital in IPOs


Venture capital stands as a cornerstone for startups looking to break into the public market with an IPO. The challenge many face is not only securing this crucial funding but also leveraging it to build a company robust enough for the scrutiny and demands of an IPO.

In the push towards an IPO, the expertise and network that venture capitalists provide are just as valuable as the capital itself.

Here, I will explain how these investors do more than write checks—they offer the strategic guidance and industry connections that can steer a startup through the complexities of going public.


What is a venture capital firm?

A venture capital (VC) firm specializes in pooling funds to invest in promising startups and early-stage ventures that show significant potential for growth. These firms usually focus on businesses that are still private, seeking financial backing to scale their operations, innovate, or enter new markets before considering a public offering.

In return for their investment, VC firms typically acquire equity in these companies, becoming not just financiers but also strategic partners. Their involvement often extends beyond capital provision; they may assume positions on the company's board, offer managerial advice and connect entrepreneurs with a valuable network of industry contacts and other resources.

With a clear understanding of the role and mechanisms of VC firms, we can turn our attention to the nuanced landscape of venture capital-backed IPOs. Here, the interplay between early investment and public launch becomes critical.

VC-backed IPOs are a testament to the venture's readiness to transition into a public entity — a move often preluded by intense preparation, scaling of operations, and strategic positioning, all fostered under the wing of venture capital partnership.

Exploring the dynamics of venture Capital-backed IPOs

A venture capital-backed IPO is when a private startup or company, previously funded by venture capital firms, offers its shares to the public for the first time. This act allows the company to gather substantial capital for future growth. For the venture capital firms that supported the company, this is a chance to sell some shares and get a return on their investment.

Now, let's discuss a vital concern. If you're considering investing in a company already funded by investors in exchange for equity, remember that the existing dilution of equity means a reduced share percentage for you. Is such an investment truly advantageous?

Steps in the venture capital-backed IPO process:

  1. Receiving venture capital: After thorough checks, a company gets venture capital funding. This funding boosts the company's valuation, expands its visibility, and typically includes a 5-year plan that outlines desired company metrics by the time of the IPO.
  2. Strategic guidance: Post-investment and before the IPO, the venture capital firm aids the company with expertise, manpower, strategic insights, and possibly more funds. This support often comes with valuations favourable to the venture capital firm.
  3. Achieving milestones: The venture capital firm guides the company towards becoming more structured. This might mean hiring an experienced Chief Financial Officer, enhancing internal controls, or producing fully audited financial statements.
  4. Engaging investment banks: Approximately 18 months before the planned IPO, the company, along with its venture capital firm, starts discussions with investment banks about potential IPO suitability. These banks then prepare pitches highlighting their strengths as potential underwriters.
  5. Studying market dynamics: After selecting an investment bank or banks, these financial institutions assess market trends. They interact with potential investors to understand their interest in the company's shares at a specific price. Positive feedback paves the way for the IPO journey.
  6. IPO due diligence: The most rigorous due diligence process then starts. The company must provide detailed documents, statements, and financial data. This exhaustive process ensures transparency and compliance ahead of the public offering.


Pros & cons of investing in venture capital-backed IPO

Venture Capital (VC) backed Initial Public Offerings (IPOs) have garnered significant attention in recent years.

Here's a deep dive into the advantages and drawbacks of investing in VC-backed IPOs.

Pros of investing in VC-backed IPOs

  • Robust growth opportunity: Companies with venture capital backing often exhibit strong growth and innovation early on. When they make their public debut, there's a significant chance to further amplify their value for shareholders.
  • Entry to early investments: VC-backed IPOs open doors for individual investors to early-stage investment avenues. Such opportunities can offer more lucrative returns compared to investing in mature firms.
  • Portfolio diversification: Venture capitalists usually spread their bets across a range of companies. This strategy offers a protective diversification. Investing in a VC-backed IPO means you get a piece of this diversified pie.
  • Seasoned leadership: A hallmark of VC-backed entities is their adept management teams and extensive industry networks. This solid foundation often instils confidence in investors about the company's growth path.
  • Trading flexibility: One of the primary perks of an IPO is the liquidity it offers. Once the company is public, its shares are up for trading, giving investors the freedom to manoeuvre their holdings.

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Cons of investing in VC-backed IPOs

The charm of VC-backed IPOs is hard to miss, but potential investors must recognize the inherent risks.

  • Elevated company worth: It's common for venture capital investments to result in sky-high startup valuations. These valuations often escalate with each funding round, leading to a towering Price-to-Earnings (PE) ratio. Meeting the returns that match these valuations becomes a tough act.
  • Potential liquidity issues: While liquidity is a standard IPO advantage, VC-backed IPOs might sometimes face the opposite. The high PE ratio can be a deterrent, making it hard for investors to offload their shares in the market. This situation can obstruct investors from realizing their profits or opting for an exit, especially during market slumps.


Examples of venture capital-backed IPOs


The Role of Venture Capital in IPOs


We learned what a VC is and its contribution for IPOs. Now let’s shift our focus to a few examples of venture capital-backed IPOs to get a sense of how it works in the practical world.

1. Google's Journey with Venture Capital

Back in the late 1990s, Google wasn't the tech giant we recognize today. Founders Larry Page and Sergei Brin believed in their new search engine's potential and sought venture capital investment.

They secured $25 million in funding, trading off 33% of their equity. This funding move gave Google a pre-money valuation of $75 million. With the added financial boost, the duo assembled a proficient team and enhanced their technology.

Fast forward to today, Google's market capitalization stands at an impressive $257 billion.

Early backers of the company rejoiced as they witnessed returns that multiplied their initial investment by almost 3,500 times.

2. Tesla

Founded in 2003 by Martin Eberhard and Marc Tarpenning, Tesla caught the attention of investors and car enthusiasts alike with its mission to accelerate the world's transition to sustainable energy.

Elon Musk joined the company early on as an investor and chairman, significantly influencing the direction of the company.

Before its public debut, Tesla raised several rounds of venture capital funding, attracting top-tier investors who believed in its electric vehicle vision.

In 2010, Tesla made its public debut on the NASDAQ under the ticker symbol "TSLA." The IPO was priced at $17 per share, raising approximately $226 million.

3. OpenTable

OpenTable, founded in 1998, revolutionized the restaurant reservation system. The platform allowed diners to book tables online, offering real-time reservation capabilities to thousands of restaurants worldwide.

Recognizing the potential of this digital disruption in the dining space, venture capitalists flocked to support OpenTable's growth. This backing allowed the company to expand its footprint, refine its technology, and secure partnerships.

In 2009, OpenTable decided to take the public route, launching its IPO on the NASDAQ. The shares were priced at $20 each, raising around $60 million.

The IPO's success highlighted the industry's faith in OpenTable's business model and the broader trend of digitizing traditional services.

4. Uber's Ride to Public Markets

Founded in 2009, Uber transformed urban mobility. The ridesharing service caught the attention of big-ticket venture capitalists, including names like Morgan Stanley, SoftBank, and G Squared. Over the years, Uber secured nearly $20 billion in funding.

Its final financing round before hitting the public market was in 2018 when it amassed $500 million. In May 2019, Uber made its much-anticipated public debut. The shares were listed at $45 each, enabling the company to raise a substantial sum of around $8 billion.


Wrapping up

The intricate relationship between venture capital firms and IPOs showcases the transformative power of strategic funding in the lifecycle of a company. From understanding the essence of a venture capital firm to navigating the dynamics of a VC-backed IPO, it's evident that such collaborations have shaped many success stories in the business world.

While investing in VC-backed IPOs offers both alluring advantages and potential pitfalls, examples like Tesla and OpenTable underline the remarkable possibilities.




You might also like to read: What is CFD trading?


“When considering initial public offering (IPO) for trading and price predictions, remember that trading CFDs involves a significant degree of risk and could result in capital loss. Past performance is not indicative of any future results. This information is provided for informative purposes only and should not be construed to be investment advice.”

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