Why famed VC Bill Gurley thinks IPOs are such a rip-off

Fortune, 2020-06-16

What Companies are Led to Believe

  • The new investors must capture the upside of the IPO price surge as a payment for the risk of the unknown. This is supposedly a low price to pay for liquidity.

  • Oversubscription of 10-30x (i.e. only 3-10% of committed investors get to buy shares) is required for liquidity. This requires lowering prices to generate this demand and turning down allocations for most investors so that they can provide a “pop” (increase in share price) immediately after the trading starts.

  • “Most prestigious” investment banks create the biggest “pop” because they choose the right companies to bring public.

Uncomfortable Truth

  • Underpricing shares at IPO for the sake of perceived “liquidity” is a flat out value transfer from existing shareholders to the new ones.

  • “Pops” are a sure sign that shares were underpriced at IPO. Indeed, this creates good publicity, but at what cost to shareholders?

  • Companies have relationships with their own cohort of analysts, investment banks can’t bang their drum.

  • “Most prestigious” investment banks bring public the companies that can afford their fees [in absolute terms] – precisely the companies with money. Self-selection.

  • After the IPO no one remembers or cares who the investment bank was.

  • Pricing by investment banks is determined by the price (and upside) appetite of IB’s largest 10-15 most prized accounts, not by the auction (supposedly closer to the market price).

  • 2018: 112 IPOs, $54B raised, $7B (17% markdown) was left on the table.

  • In down markets it’s easy to confuse clients into pricing low.

Possible Solution(s) – direct listing

  • Securities prices (incl. IPO shares) to be established by market means [MK: how to do it without an already established market for these shares? Auction?]

  • Selling investors/shareholders must be able to buy new shares at IPO, too.