Founders may have inadvertently granted VCs too much power to block an IPO
While some investors are vocal about the IPO window not staying closed forever, other VCs themselves are contributing to the issue.
A significant number of standard VC deal terms provide investors with the ability to block an IPO or acquisition if they believe the timing or price is not favorable, as explained by Eric Weiner, a partner at Lowenstein Sandler, in an interview with TechCrunch. While it is uncommon for investors to include direct language for blocking an IPO, there are fundamental deal terms that essentially grant investors with preferred shares similar authority, he added.
Investors with preferred shares have more control than common stockholders and usually have a say, often a vote, in situations where a company is about to undertake an action that would dilute their shares or convert them to common stock, such as in the case of an IPO. “Going public is not a simple process,” Weiner remarked. “Many factors need to align.”
Ryan Hinkle, a managing director at Insight Partners, emphasized that for a company to go public, it needs the agreement of its investors with preferred shares, especially those who set the terms in the most recent funding round. In a strong market, investors and founders are likely to agree on the ideal timing for an IPO. The founder may be willing to exit below the startup’s previous valuation, but the investors must also be on board.
Hinkle explained the implications for VC shares post-IPO, stating that any preferential treatment in the stock, such as a 1x liquidation preference, disappears. The last investor from the most recent funding round essentially needs to support the IPO for it to proceed.
Notwithstanding, the abundant rights granted to late-stage investors in 2021 have likely caused difficulties for many startups. When startups raised funding at inflated valuations in 2021, they may not have realized the extent of power they were relinquishing to their late-stage investors if the market cooled, which it did.
Alan Vaksman, a founding partner at Launchbay Capital, highlighted the friction between investors and startups regarding the decision to go public, attributing it partly to the investors’ fiduciary duty to maximize returns for their LPs. Vaksman stressed the need for smart financial decisions that could lead to higher returns.
Hinkle and Vaksman also pointed out the evolving expectations of the public markets, emphasizing the importance of strong growth and financial metrics before going public. They also noted the role of secondary markets in providing liquidity to VCs without the need for pressured IPOs.
While tensions may arise between founders and VCs regarding IPO decisions, such conflicts could ultimately benefit startups, VCs, and their investors.
Given the current global uncertainties, such as geopolitical tensions and economic fluctuations, Hinkle expressed skepticism about a surge in IPOs this year.
