“The IPO is the last chance for companies that have become too big”
28 Apr 2021
Alex Hofmann, 06:00, 28 Apr 2021
Until now, going public was hardly an option for startups – and founders and VCs alike were resigned to it. What needs to change now in terms of financing?
A banker and an M&A expert: Lars Kuppe and Mark Miller see many opportunities in IPOs – but also many false enticements
Until a few weeks ago, IPOs were the absolute exception in the German startup scene. Now, the IPO rumors and announcements are virtually overflowing. Companies like Enpal, Personio, Babbel or Mister Spex are said to have concrete plans to go public, Auto1 has already successfully completed the step and with the hyped Spacs, for example from Lakestar or the scene heads Dominik Richter and Roman Kirsch, there are further possibilities to bring a company to the stock exchange.
Which begs the question: How will founding in Germany change if the stock exchange becomes one of the most important exit channels in the long term? After all, it functions according to completely different rules than, for example, the sale of the startup to corporations, medium-sized companies or private equity firms. And not only in terms of transparency obligations, but also in terms of key figures. For a successful IPO, for example, profits must be much more tangible. Nor does the IPO involve a network, as is often the case when a company is acquired by a private equity firm and incorporated into its portfolio.
Investors have (too) much money
“The trend toward more IPOs is spilling over to us from the U.S.,” says Lars Kuppe, director of private markets at Bankhaus Lampe. “In the U.S., 2020 was a very successful year for IPOs.” In his view, that’s because there’s a lot of liquidity in the market. Too much, in fact: Because there is a need to invest it, investors are less choosy than before, says the Düsseldorf-based bank manager. This also explains the hype around Spacs: They are supposed to find investment targets because investors cannot do that fast enough themselves. Since the situation in Germany is not much different, Kuppe expects many IPOs on this side of the Atlantic as well.
How does a spac actually work – and how far does the hype go? Answers to the most important questions
The consequences for startups are already being felt, he says. “The valuation levels for IPOs are now in some cases higher than those for M&A transactions,” says Kuppe. In other words, an IPO promises investors higher returns than selling the startup to another company. Many venture capitalists have therefore already set up so-called opportunity funds, with which they invest in more mature companies. With a fairly short investment horizon, the rosy stock market prospects promise very attractive returns.
However, Kuppe says that the past has often shown that not every company is suitable for the stock market. For example, in e-commerce: While the fashion mail order company Zalando and the fresh food delivery service Hellofresh celebrated ever new share price records, the shares of the furniture retailer Home24 plummeted after the IPO and have not been able to recover to date, despite Corona-induced growth.
The stock market climate is overheated
For startups that cannot sustain their growth from current business, but are dependent on outside capital even after the IPO, a special problem arises on the stock market: what if the share price is in a trough just when the need for capital is acute? Then issuing new shares becomes expensive to impossible. “In order to avoid a price slump after the IPO and still achieve adequate demand after the first listing, the valuation level must not be stretched too far when going public,” says Kuppe. The only thing is that both private investors and the banks accompanying the IPO are naturally interested in the largest possible IPOs. After all, they want to maximize their returns.
So is the current IPO hype good or bad? “The exit opportunities for companies with venture capital financing are being significantly revitalized, because IPOs as an exit option in Germany were only available to profitable companies for a long time, and that is changing,” says Kuppe. And is the stock market climate already overheated? “According to my feeling: yes,” says the banker. However, he does not currently recognize a bubble, i.e. generally exaggerated company values, “even though not all valuations will certainly be justified.”
M&A expert Mark Miller of Carlsquare Corporate Finance also sees a danger in this. “Valuations that are too high increase the risk that IPOs will perform poorly in the medium term. And that can lead to investors shying away. Then the stock market hype would quickly be over,” he warns. From Miller’s perspective, that’s not the only danger. “Right now, there is a clear focus on lockdown-driven business models,” he observes. “They have to prove first that they can still deliver high growth rates after the pandemic.”
But because many of the business models relied on recurring revenue, Miller also sees the IPO hype as positive. “In Germany, companies are often sold too early, long before they reach a good size,” says the M&A expert. He says this is also due to the fact that a market capitalization of one billion euros is almost a requirement for an IPO in Germany. “There hasn’t been a liquid market between 100 and 500 million euros in Germany in recent years.”
VCs can relax
At Nasdaq Stockholm, for example, things are different, says Miller. There, conditions would also play better into the cards of smaller companies, especially in the tech segment. “With IPO opportunities below the billion mark, investors can be more relaxed – and at the same time invest more ambitiously.” Miller’s logic: because a more realistic exit alternative exists even when companies aren’t worth a billion euros, venture capital investors don’t come under time pressure as the end of the fund’s life approaches and their own backers want to see redemptions.
Overall, Miller sees the stock market as necessary for many companies. “The IPO is the last chance for companies without an ‘ultimate owner,'” he says – those VC-funded startups that have grown too large to be acquired by a mid-sized company or corporation. The growing international interest in German companies can do little to change that, he adds. That’s because takeovers of companies that are far along in their development are still the exception.
On the one hand, the new stock market opportunities do bring risks with them, especially with regard to exaggerated valuations. On the other hand, however, they also lead to significant advantages: Above all, because VCs have more opportunities to sell their investments, founders have greater flexibility when planning their long-term (exit) strategy. To ensure that the pendulum swings in the right direction for the startup scene, i.e. that the stock market establishes itself as a good exit channel in the long term, Miller sees only one proven means: “It needs success stories.”