Silicon Valley Is Hoarding Wealth by Skipping IPOs

Andrew DeGraff

Uber CEO Travis Kalanick is famous for saying things that make him sound like tech's Dr. Evil, but now he's spouting his most damaging rhetoric yet: He vows that Uber won't go public for another decade. He adds that he'll finally do an initial public offering (IPO) "one day before my employees and significant others come to my office with pitchforks and torches."

Well, maybe it's time for that witch hunt. Data show that if Kalanick keeps Uber private for the next 10 years, his company will likely flatline, and concern regarding his truculence is now about more than just Uber. It's about all of us, and it's about the world's growing and volatile income gap. Kalanick is looking straight at America's middle class—the kind of people who might want to buy his stock as a way to build some wealth—and telling us to fuck off.

Worse yet, too much of the technology startup ecosystem stands with him. The most dynamic industry on the planet has been actively deciding to keep as much for itself as possible and shut out the rest of the populace by avoiding public stock offerings.

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As I write this, a reasonably successful tech company—Twilio, which is obscure enough that you might think it's the name of a new licorice candy—is about to go public. The markets are celebrating this event the way parents exude over their baby's first word. Before Twilio, the number of so-called tech unicorns going public in 2016 totaled zero. In all of 2015, only five went public. Go back to 2006, and there were 84 tech IPOs for the year.

(By the way, billion-dollar private companies aren't unicorns these days. They're more like rabbits, propagating everywhere. If that keeps up, they'll turn into a plague.)

Staying private has deep implications. While researching our book, Play Bigger, my colleagues Al Ramadan, Dave Peterson and Christopher Lochhead analyzed data about thousands of venture-backed tech companies founded since 2000. They found something that at first seemed weird: The data show that the best time for a company to go public is when it is between six and 10 years old. Cisco, Google, VMware and Facebook are among the many enduring companies that went public in that sweet spot.

The age of a company at IPO mattered more to post-IPO value creation than the amount invested in a company while it was private. There is zero correlation between the amount of money raised by a company before it goes public and its post-IPO value creation. Keep that in mind the next time you read about a billion-dollar private financing round.

Stock in companies that went public before six years often cratered later. Groupon went public at three years old, and that didn't go well. Stock in companies that went public after 10 years almost always stayed pretty flat, puttering along on fumes.

We figured out why the sweet spot is a real thing when we looked at studies about how new markets evolve. From its inception, a new category of product or service needs years to work itself out and get to mainstream, usually with a bunch of newcomers fighting to be the category king. After five or six years, one company nails it, competitors fall away, and the category takes flight. The biggest spike in almost every new category's growth comes within that six- to 10-year window.

For Silicon Valley unicorns, staying private too long is like living with a parent too long—sooner or later, you lose the wherewithal to succeed in the real world. Dan Krauss/Gallery Stock

A decade after the new category king was born, the explosive growth is fading. The product or service by that point has penetrated most of its target market. Intense excitement just turns into a good solid enduring business—the kind that rarely generates hockey-stick stock gains.

We saw this pattern over and over. We presented the finding to investment bankers and venture capitalists, and they said it matches their gut instincts.

The data, then, provide a new lens on why someone like Kalanick seems to be screwing both his company and the public. If a company goes public in the sweet spot, it takes a broad swath of investors on the rocket ride up. Almost anyone can participate in that explosive value creation. When a company stays private for more than 10 years, the only people who get that explosive value creation are the relatively small cadre of private investors, the company's founders and the early employees. This is how the rich stay richer.

Uber is now seven years old. Staying private until year 15 or 17 would be uncharted territory for a company in Uber's position. If past is prologue, going public in year 15 or 17 would be an insult to future stockholders. The great value creation will likely have ended. Kalanick and his inner circle will have feasted and thrown everyone else the scraps.

Some of the great companies, after their initial category-building surge, expand into an entirely new category and restart the cycle. Think of Amazon creating Amazon Web Services for the cloud in 2006, 12 years after the company was founded. Maybe Uber will be like that. Maybe it won't. Let's just say that what Amazon did is rare.

And why might a late IPO screw the company? There seems to be a bunch of reasons. Talented people avoid joining the company unless they can get stock and participate in the big run-up. The absence of the oversight imposed on public companies can make a private firm sloppy about its finances. The company doesn't have stock for acquisitions. Staying private too long is like living with your mom too long—sooner or later, you lose the wherewithal to succeed in the real world.

Facebook CEO Mark Zuckerberg for years said companies should stay private as long as possible. After going public, he changed his mind. "I actually think that it's made our company a lot stronger," he said at a TechCrunch conference. "We run our company a lot better now."

To be fair, the bias against going public isn't completely crazy. An IPO is a pain in the ass. It costs millions of dollars. It forces CEOs to focus on quarterly earnings, sometimes to the detriment of the long run. Sarbanes-Oxley regulations impose a burden. And there's so much private money wanting to get into tech that any company with a pulse can raise round after round. So why bother with an IPO? One survey showed that just 17 percent of Silicon Valley companies even say an IPO is a goal, ever.

But the data show why they should bother. For the company's sake, there's a great time to go public, just like there's a right time to take the pie out of the oven. But there's a bigger public good at risk too. If Silicon Valley doesn't rethink its stance about IPOs, it might not be—as Kalanick joked—employees and significant others showing up with pitchforks and torches.

It might be all the rest of us.