While raising capital, it’s best to have a bull market supporting your company’s potential valuations. When prices are rising in the broader markets, venture capital funds and angel investors will be willing to pay you more. LinkedIn is the latest example of this principle in motion.
LinkedIn’s IPO, and the investors exit
The company completed a small initial public offering in May. Less than 10% of the outstanding shares were sold in the offering, creating a very small supply. When demand is high and supply is low, prices drive up – and that’s exactly what happened.
The price of LinkedIn’s stock surged on it’s opening, closing up 109% by the end of its first day of trading. LinkedIn suddenly boasted a market capitalization worth USD $8.9 billion. The bull market for the stock continued a while longer and the value of the company peaked about two months later at USD $11.5 billion.
Was LinkedIn a successful IPO?
At its peak, LinkedIn had a price-to-earnings (P/E) ratio of more than 800. The long-term average P/E ratio in the stock market is about 15. LinkedIn may be a growth stock, but they don’t expect to make a profit next year.
LinkedIn is just a company with a good idea and platform. But many other colossal IPO failures, like the memorable yet complete black hole that was Pets.com, have been based on good ideas, too.
So whether you consider LinkedIn’s IPO successful or not depends on which side of the market you sit on. For the angel investors, it was so lucrative you would think it should be illegal. But for the broader market, and especially for entrepreneurs looking to raise capital, it could yet be another breath into a tech bubble that’s about to pop.
How will the LinkedIn IPO affect new issues coming out this and next year?
Groupon was hoping to be next to let early private capitalists and angel investors cash out. They filed paperwork to do an IPO, but two problems may delay a big payday for investors.
First, potential investors and the U.S. Securities and Exchange Commission questioned the company’s creative accounting. In 2010, following Generally Accepted Accounting Principles (GAAP), Groupon lost USD $420 million. But the company also reported what they called adjusted consolidated segment operating income, and that measure shows a profit of USD $60 million.
To get there, Groupon excluded marketing costs and a few other expenses. Investors don’t like to see financial trickery from companies, especially early in their life cycle.
As investors pondered why a company would report a nonstandard and questionable earnings number, the U.S. stock market plummeted. Prices of the major indexes fell nearly 20% in three weeks, and many stocks fared even worse. LinkedIn fell 38%.
That could make it more difficult for companies toying with a potential blockbuster IPO like Groupon to have a successful stock offering. The company may proceed and sell shares in a bear market, but the eyebrows they’ve raised with the adjusted earnings combined with a declining market could end up costing investors billions.
What can entrepreneurs take away?
As you think about raising capital, there are important lessons to be learned from LinkedIn and Groupon. Take advantage of market conditions, as LinkedIn did, to maximize the amount of capital you receive. Also, present your numbers cleanly, and use non-GAAP measures to clarify your earnings without raising questions. This will give private equity investors confidence in the company’s management, as well as the retail and institutional investors in the public market.