Founders may have inadvertently granted VCs excessive power to block an IPO
While some investors are loudly bemoaning that the IPO window can’t stay shut forever, other VCs themselves are actually part of the problem.
A lot of standard VC deal terms give investors the ability to block an IPO or acquisition if they didn’t think the timing or price was right, according to Eric Weiner, a partner at Lowenstein Sandler. While it’s relatively uncommon for investors to explicitly have the power to block an IPO, there are deal terms that allow investors with preferred shares to effectively do the same.
Investors with preferred shares hold more influence and have a say, typically a vote, when it comes to events that could dilute their shares or convert them to common stock, like an IPO. “It’s not easy to go public,” Weiner explained. “A lot of things have to align.”
Before a company can go public, its investors with preferred shares, especially those dictating terms in the latest funding round, must be in favor of an IPO. In a favorable market, investors and founders are likely to agree on the optimal time for an IPO. However, investor approval is crucial, even if a founder is willing to exit below the startup’s last valuation.
Ryan Hinkle, a managing director at Insight Partners, highlighted the changes that occur to VC shares after an IPO, emphasizing that the last investor’s stance can determine the fate of the IPO. Terms like 1x liquidation preference control the repayment hierarchy in acquisitions, highlighting the power held by late-stage investors.
Startups that raised capital at high valuations in 2021 might have unwittingly given their late-stage investors considerable control. It’s essential for founders to be aware of the rights they are granting and the potential implications if the market conditions shift.
Investors have a fiduciary duty to their LPs to make sound financial decisions, which can involve challenging decisions around when to pursue an IPO. The public markets’ expectations have evolved, emphasizing profitability and margins, shifting the focus from growth metrics.
Secondary markets offer VCs liquidity options without pressuring startups to go public prematurely. While tensions between founders and VCs can arise, navigating these challenges can lead to positive outcomes for all parties involved.
Uncertainty in the current global landscape, such as geopolitical tensions and economic factors, may dampen the IPO market in the near future. A return to booming IPOs might not be expected in the immediate calendar year.
