The IPO fertility problem

Over the course of the last nine months or so (in the ‘what have you actually been doing with your life’ question which my mother routinely asks), I’ve looked at a lot, a LOT, of companies that are operating within a couple of concentric circles of the Fortnite, Roblox and Discord ecosystems. The general lack of VC investing is breeding a fascinating cohort of (relatively) bootstrapped startups doing interesting things. 

It turns out this is not a unique trend.

The average number of VC-backed software companies in the US in the last three years is now less than a third of the average over the last decade. I speculated a while back that the post-ZIRP cohort of founders might be something special. And whether it’s a philosophical aversion to VC or just an inability to raise because you’re not the hot thing, it’s going to lead to some intriguing outcomes. Possible futures I think about include:

Outcome 1: an increase in smaller M&A (perhaps raising the average exit rate) which makes founders wealthy, makes acquiring companies sort of happy because no crazy valuations. VCs are sad. Probably less or slower IPO funnel.

Outcome 2: bootstrapped or one-cheque only companies eventually take some VC money to do the 10x scale thing. Can probably name their price for term sheets. VCs are not wildly happy but write blog posts saying they are and pray for strategic acquisitions. Probably less companies in the IPO funnel too.

Outcome 3: on average nothing really changes. IPO funnel stays as it is. 

You might think I’m writing this to make you feel sorry for VCs. I’m not! They are fine and will be fine and will find many newsletters and podcasts to tell you as much. No, I’m actually more interested in the impact of these trends on the public markets. 

Even before any impact from the potential scenarios I listed, the lack of recent software IPOs has had a distinct grey-hairing effect on the public markets: Right now the average age of a publicly listed software company is 20yrs (and growth for many of these are now beginning to naturally slow down). 

In corporate demographic terms (at least for software and tech), we have an IPO fertility problem. 

One of the big contributors to this situation is that recent capital markets have allowed more companies to stay private for longer. And that seems to be leading to flabbier IPO candidates. A fact that Jamin Ball nailed perfectly in a recent post:

Here’s the challenge. The private markets are FULL of companies who were growing 50-100% at ~$100m of ARR. And the reality today is many of those are now growing <20% at $200-$300m ARR. TAMs were captured sooner and companies didn’t scale into their next product line, large incumbents bundled them, execution challenges popped up, etc. 

Right now, the general chatter amongst investors is that companies looking for a successful IPO need to be at $500m-$1b with 20% annual growth and at least cashflow break-even. That’s a very, very high bar (which also excludes any AI noise) and you’d be right in thinking that most companies don’t hit it. When you compound that with an emerging trend of founders who are getting much more comfortable building smaller things, it really makes you wonder what the environment is going to look like in ten years time…

Now, on one hand public markets are not for everyone. And if you’re a founder who’s been paying any attention to the whipsaw market behavior over the last few years you might well conclude ‘also not for me!’ and starting dialling up some PE firms instead to have a chat. 

But on the other hand, we really, really need more public (high quality) software (ish) companies.

So what can be done to increase the IPO fertility rate for software companies?

• In theory, junior public markets like the UK’s AIM were meant to tackle this exact problem although that’s clearly not working (it’s an interesting counter-factual for what the UK could have been in the global tech ecosystem).

• I assume there’s some impossibly clever PM in a Citadel pod somewhere who’s currently working on a more public version of private market secondaries (maybe somewhere between Eric Ries’ Long-Term Stock Exchange and the Destiny Tech 100). 

• The ‘let’s just blame VC for everything’ camp would probably suggest some kind of Glass-Steagall equivalent where VCs are allowed to invest but someone else has to do the valuation work.

What a fascinating landscape.

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Reading/listening

• I interviewed Sean Blanchfield about the real history of Demonware and (some of) the origins of multiplayer gaming. It is excellent and you should listen.

• This excellent conversation between investors Brad Gerstner and Bill Gurley who talked through various aspects of what I just wrote about.

• The equivalent of the Kendrick/Drake battle happening in archaeology/ancient history right now

• The dullest-sounding yet utterly fascinating history of management consulting