The Lucrative Tech IPO Opportunity: Grasp it before it’s gone!

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For nearly two years there were no major technology Initial Public Offerings (IPOs). However, three significant IPOs recently took place in quick succession. Arm, a chip designer, Instacart, an online grocery delivery service, and Klaviyo, a marketing automation company, all followed a similar pattern. They priced their shares at or above the upper end of their estimated ranges, experienced substantial gains on their debut, and then experienced a slight decline. This confirms that the “IPO window” for tech and other companies to go public is open once again after closing due to rising inflation and interest rates following a record-breaking 2021. However, it is still not fully open.

All three IPOs had unique characteristics. The owners sold only about 10% of their shares, indicating less focus on maximizing initial profits and more interest in ensuring strong post-IPO trading. For SoftBank, the owner of Arm, the chip designer remains its most valuable asset. SoftBank took a cautious approach, enlisting four lead banks and 24 additional bookrunners, effectively leveraging much of Wall Street’s support for the deal.

Limited free floats, such as the ones for Arm, can create a squeeze that drives up prices. The average free float for US IPOs over the past five years has been around 20%, with the London Stock Exchange requiring a minimum of 10%. All three companies also allocated shares to “cornerstone” investors. Arm included tech giants like Apple and Google, while Instacart’s cornerstone investors included Sequoia Capital, the venture capital firm, and several of its existing private backers, who were lined up to buy up to three-fifths of the deal — an unconventional approach.

Despite these efforts, Instacart’s valuation during the IPO was only a quarter of its peak private valuation of $39 billion two years ago, while Arm and Klaviyo were closer to their previous private valuations. This suggests that there is renewed market appetite for tech company shares, but with certain limitations in place.

It is important to note that this does not signal a return to the 2021 IPO boom, when valuations reached unprecedented levels and many investors suffered losses. Goldman Sachs found that IPOs during the 2020-2021 wave performed poorly compared to historical trends, with the median offering underperforming the broader US market by 48 percentage points in the following 12 months. Today, investors prioritize profitability and positive cash flow rather than promises of future growth.

So, where does this leave the multitude of venture capital-backed tech and startup companies that have been starved of funding during the downturn and have been waiting for market conditions to improve? Some companies, like Instacart, may opt for a “down round” IPO, which involves a valuation cut compared to their previous private valuations, particularly if there are specific financial requirements to meet. Additionally, private backers who have invested in earlier funding rounds may still be able to sell their shares at a decent premium.

This will at least bring some clarity to private tech valuations, which have been uncertain. By selling existing holdings, VC investors can free up capital to invest in new ventures. The years of abundant private funding and low interest rates have led to startups staying private for longer periods. Taking them public exposes them to greater scrutiny and allows retail investors to participate in their potential value creation.

Public equity markets are the foundation of capitalism, and dynamic growth companies should thrive in public markets. If this cycle is restarting with a more realistic approach from investors, it will be beneficial for everyone involved.