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Fixing the Brain Damage Caused by the

I.P.O. Process
Andrew Ross Sorkin

DEALBOOK SEPT. 18, 2017

It seems like a way of living in hell without dying.

That was the way James Freeman, the founder of Blue Bottle Coffee, described
the process of taking a company public in the modern era and the way he
explained why he sold his company instead to Nestl last week.

It is no secret that the public stock markets despite the heights theyve
reached (and the credit that President Trump has taken for them) are
fundamentally broken. No chief executive wants to live in the glare of the public
spotlight and deal with pesky investors who hold stocks in time frames of days and
months, not years and decades.

The number of companies listed on public stock exchanges is half what it was
two decades ago. Last year, fewer companies went public than during the financial
crisis.

Its a strange world. If it was 10 years ago, wed be public by now, Stewart
Butterfield, chief executive of Slack, an office messaging company worth $5.1 billion,
told The Financial Times over the weekend.
 Now, a series of entrepreneurs are emerging with some novel ways to fix the
problem. Last week, Chamath Palihapitiya, a brash entrepreneur who was an early
Facebook employee, launched a public company known as a special purpose
acquisition company, or a blank check company, with $600 million put up by
investors. The intent is to merge with one of Silicon Valleys unicorns, taking it
public through a back door of sorts.

The idea is to remove the process of going public that is true brain damage, Mr.
Palihapitiya said.

At the same time, Spotify, the streaming music company worth some $13
billion, has been exploring a plan to list its shares on the New York Stock Exchange
directly, without raising any new money from public investors.

Perhaps the most ambitious and provocative effort is a company that until now
was in stealth mode: LTSE (Long-Term Stock Exchange), led by the entrepreneur
Eric Ries. Backed by a whos who of venture-capital investors Marc Andreessen,
Reid Hoffman and Steve Case among them the new exchange aims to reimagine
what it means to even be a public company. Among its changes to the ecosystem: the
voting rights of investors (the longer you own, the more voting power you have), new
disclosure policies (including a moratorium on guidance) and a complete rewrite
of compensation schemes so that executives truly focus on the long term (it
recommends vesting stock over as long as a decade).

Before we go too far down the rabbit hole of how to fix the problem, it is worth
understanding how the I.P.O. process and the markets themselves became so
broken.

To hear Mr. Palihapitiya tell it, the shift at least in Silicon Valley began
during the financial crisis, when he was working at Facebook. His candid
explanation is surprising.

We at Facebook basically flipped the narrative, and we did it on purpose, he

said. Our whole thing was Lets stay private longer. And the reason we did that was
we were pretty sure it would trick a lot of other people into not trying to go public or
take advantage of the capital markets.
 He said Facebook hoped that all those companies would eventually die because
they were not that good and we would suck up all of their talent.

Whether it was a trick or not, stay private longer became a mantra in Silicon
Valley. And given all the cash sloshing around the technology industry, companies
have been able to put off going public without going broke.

But it has created all sorts of problems, not least of which is that employees have
felt that their social contract with companies working for little salary but lots of
stock on the assumption the companies would go public has fallen apart. And it
may very well be affecting innovation.

Mr. Palihapitiya said the lament of many employees had become this: I cant
pay for my house on mission and values. I actually need current compensation.
Silicon Valley is now one of the most expensive places to live. So many employees,
he explained, have been hopscotching from one company to the next in search of an
elusive I.P.O.

Now you have these attrition rates of like 20-plus percent, he said. How are
you supposed to build an iconic legacy business when your entire employee base
walks out the door every five years?

Mr. Palihapitiyas answer is to eliminate the I.P.O. process and its year and a
half of distractions trying to craft a bogus narrative, as he described it, to entice
investors. Instead, through his publicly traded vehicle, a unicorn company
shorthand for a $1 billion-plus private technology company could reverse merge
into it, instantly becoming public.

Unlike an initial public offering, in which employees and early investors all have
certain lockup dates for when they can sell stock, he can write the rules however
the company wants. Certain employees, for instance, could sell early, or the sales
could be staggered so there isnt an overhang on the stock that would depress the
price before a major lockup period expired.

Mr. Palihapitiya also was able to choose most of the companys big investors,
who have agreed to their own lockups, making them much more oriented toward the
long term. For all this, he takes a tidy fee: 20 percent of the $600 million. But if his
company acquires a business five to 20 times its size through a reverse merger, he
said, the fee is the same as or smaller than a bankers fee and it is all in stock, so
unlike the banks, Mr. Palihapitiyas interests are aligned with the companys.

But Mr. Palihapitiyas approach is just the tip of the iceberg. The most
provocative plan floating around Silicon Valley is Mr. Riess LTSE. Its an
intellectually thoughtful idea, Mr. Palihapitiya said.

The idea, at its core, is to change the dynamic between the stock exchange and
whom it serves, Mr. Ries explained, suggesting that traditional stock exchanges focus
more on investors and all associated trading revenue than on the companies
listed. That, he believes, leads to short-term thinking and trading.

Mr. Ries, who wrote a book titled The Lean Startup, is hoping to create an
exchange that is focused on the needs of companies with a long-term vision and
investors who are similarly aligned. He believes the problem facing private
companies isnt just the I.P.O. process but also the lived experience of being a public
company.

Perhaps the most unusual part of his exchanges approach which is still
working to get approval from the Securities and Exchange Commission is how
much influence and voting power investors would have over companies.

Currently, an investor who owns one share for a month, or even a day, has the
same voting power as someone who has owned a share for years. Mr. Ries wants
what he calls tourists short-term shareholders to have less voting power than
long-term shareholders, whom he calls citizens of the republic. Over time,
shareholders of companies on the LTSE would gain more votes based on their length
of ownership.

Such a system might make dual-class structures, like at Snap (or The New York
Times) less attractive to its founders. That would also help end another problem that
has emerged: Dual-class companies pay the chief executive, on average, three times
as much as companies with a single share class.
 Mr. Ries also takes aim at compensation plans. He wants companies that list on
his exchange to have stock vesting programs of at least five years and recommends
10 years, even for executives who leave the company.

Now, this may be very hard to put into practice, and its tough to know whether
it would work. Its very difficult, Mr. Palihapitiya said. Ours is not as intellectually
ambitious. But all of these efforts are meaningful attempts to fix the system. Even if
they dont work as advertised, hopefully the establishment will take notes.

A version of this article appears in print on September 19, 2017, on Page B1 of the New York edition with
the headline: The Profits of Going Public Without the Brain Damage.

2017 The New York Times Company