Why staying private sucks, if you’re a tech company

Three years ago, I wrote a feature for Wired under the headline “For High Tech Companies, Going Public Sucks.” It was illustrated with a picture of a frowny-faced Mark Zuckerberg, who was clearly not happy about the prospect of Facebook going public.

And yet, its disastrous IPO notwithstanding, going public has turned out very well for Facebook. The stock price has doubled from where it closed on its first day of trading, and the company has announced a series of acquisitions, including its massive $22 billion deal for WhatsApp, that would have been impossible as a private company. By using the power of his share price, Zuckerberg now owns not only the social network he built, but also rival networks.

Facebook is now as firmly ensconced as any technology company can ever be. It has a dual-class share structure that keeps Zuckerberg firmly in control, while also allowing the company to issue pretty much as much new equity as it likes. That useful when you’re in acquisition mode, of course. But more importantly, it’s a very powerful tool that can be used to attract and retain employees. If you work at a start-up and are given equity, that stock is basically a lottery ticket; chances are, it’s going to end up being worth little or nothing. If you work at Facebook, on the other hand, your stock grants have real value. Sure, you don’t know exactly how much they’re going to end up being worth. But it’ll probably be a substantial sum, and there’s still a lot of upside.

So while there are good reasons that growing tech companies like Uber prefer not to go public, there are also real downsides to staying private.

Firstly, being public gives companies a lot more flexibility in terms of financing. Because all their finances are public, it’s relatively easy to borrow money; it’s rare for private companies to issue bonds, for instance, and when they do borrow, it’s often convertible debt that can prove very expensive if and when the valuation of the company rises.

More importantly, public companies can issue new equity at whatever today’s price is. Stocks go up and stocks go down—all investors are okay with that. And some employees even love when the stock price goes down, because it means they get more stock units at compensation time. The dollar value is the same, but the potential gain is higher.

At private companies, however, there is a very strong convention against “down rounds.” If you last raised money at, say, a $1 billion valuation, then that’s the valuation that’s going to be attached to all current stock grants, even if no one would invest today at anything higher than a $300 million valuation. Should your company need to raise more money to keep on going, it will find it very difficult to do so at any valuation below $1 billion—and it might even go bust as a result. If your company had gone public at that $1 billion valuation, by contrast, then it would find it comparatively easy to raise new equity, even if its shares had dropped by 70 percent.

Certainly, going public doesn’t seem to crimp companies’ ability to innovate. Keith Rabois, of Khosla Ventures, says that at one of his portfolio companies, Yelp, going public was “the best thing ever for the company.” And look at the giants of Silicon Valley, he adds: no one thinks Apple and Google and Amazon are suffering at all from being public companies.

Staying private can be its own constraint. Consider eClinicalWorks, a private company that has pledged never to go public. Its founders have made a complicated and deliberate decision not to get incredibly rich, and the company only manages to retain its workforce by putting in place a profit-sharing plan. Which means that whenever eClinicalWorks decides to invest in future growth, that immediately hurts the take-home pay of all its employees.

Finally, there’s the concern about staying private raised by Bill Gurley, of Benchmark Capital. His talk about the “liquidation preference stack” and “calcified cap tables” can be hard to follow, but it’s important.

Gurley’s concern is about money-losing companies that raise a long sequence of ever-larger rounds at ever-higher valuations. That sounds exactly how the Silicon Valley financing universe should work. But here’s the rub: while everybody likes to talk about the valuations, no one likes to talk about another key part of these financing deals—the liquidation preferences. When VCs invest in money-losing companies, they invariably include a clause that guarantees them a minimum amount of money if the company is ever sold or goes public. In other words, you might invest $100 million in Uber at a $40 billion valuation, but if you have a 1.5x liquidity preference, then you’re guaranteed to get at least $150 million back, if and when it goes public, no matter how much your stock is worth at the time.

If companies raise round after round of venture capital, with each round having its own liquidation preference, then the result is that anybody without a liquidation preference (read: most employees, and anybody else with common stock) could easily be left with nothing at all in the event of the company being sold. You think you own a certain percentage of the company, but all of the proceeds from any sale have to go first to pay off obligations to VCs, and after that there might be nothing left.

The result is that it can become very hard to attract talent, and it can also become much more difficult than it should be for a CEO to accept the kind of strategic offer that might be good for the company. If the offer isn’t for a huge amount of money, then all of the sweat equity put in by workers and management might well be for naught.

Ultimately, fast-growing companies are always going to face problems—the glare of public scrutiny, if they’re public, or the dangerous expectations of venture capitalists, if they’re private. And it’s not at all obvious that the latter is preferable to the former.

Maybe the best solution is not to take any outside funding at all, and not to try to grow too fast. Some family companies have been around for hundreds of years: if you own your own business, and you don’t get greedy, you can build a very pleasant life for yourself. You just won’t end up on any list of young billionaires.