Bill Gurley, general partner of Benchmark Capital Holdings Co.
Patrick T. Fallon | Bloomberg | Getty Images
Ever since an appearance on CNBC last month in which he described the IPO process as a “bad joke” for Silicon Valley, the venture capitalist’s Twitter feed and public commentary has been largely focused on promoting direct listings as a modern and capital-preserving alternative to the typical initial share sale.
IPOs, Gurley says, represent a gift to Wall Street banks, who get to handpick the new investors and offer them a stake in Silicon Valley’s shiny new object at what amounts to a steep discount because of the built-in first-day pop. The banks get paid to manage the process but, more than that, they often get to buy tens of millions of dollars in stock at the IPO price and reap immediate, massive gains when the stock pops.
This week, Gurley gathered more than 100 CEOs of late-stage private tech companies and another 200 or so CFOs, venture capitalists and fund managers for an invitation-only event in San Francisco called “Direct Listings: A Simpler and Superior Alternative to the IPO.”
“Most people are afraid of backlash from the banks so they don’t speak out,” Gurley, a partner at venture firm Benchmark, said in a follow-up chat with CNBC on Thursday, while walking through the slide deck from the seminar. “I’m at a point in my career where I can handle the heat.”
Sign for Bill Gurley’s direct listing event
Ari Levy | CNBC
But what do the companies think?
As Gurley knows, there’s another side to the story.
Zoom, which makes a popular videoconferencing service, more than quadrupled its cash and marketable securities position to over $730 million after its IPO in April. So did cloud security vendor CrowdStrike, to more than $825 million. Yes, both companies left potentially hundreds of millions of dollars on the table after their stocks immediately surged more than 70%, but they’re still in much stronger financial positions than ever and they’ve received a huge bump in exposure that helped bring in new customers.
Zoom CFO Kelly Steckelberg said in an email to CNBC that Zoom “got the most added attention in the financial community,” and even picked up business from several of its IPO banks who she said are “trialing or have standardized on Zoom now.”
In its quarterly earnings report last month, Zoom said its number of customers with at least 10 employees was up to 66,300, rising 78% from a year earlier and 31% from just before the IPO. That’s a lot of recurring revenue.
CrowdStrike CEO George Kurtz said in an interview that his company’s IPO brought more awareness to its brand in what’s been “a very noisy space” and allowed it “to showcase what we do and how we do it on a much broader stage, particularly internationally.”
As for direct listings, Steckelberg said the process “hasn’t been proven yet,” while Kurtz said, “we thought this model worked for us and we were happy with the outcome.”
CrowdStrike IPO at the Nasdaq exchange June 12, 2019.
That all raises an important question: If the companies that are supposedly getting fleeced the worst by the IPO process aren’t complaining about it and are actually quite satisfied, where is the problem?
“I have zero doubt that someone that just did the biggest transaction and most important financial event of their life is going to answer that way,” Gurley said in a text message response. He added, “I don’t think being short term oriented is the right way to think about financial markets.”
How Gurley came around
Gurley has long been critical of the IPO process and the show that top investment bankers roll out for hot companies so they can win their business and take them on the road to meet the big money players. But his obsession with direct listings is a new thing.
Spotify pioneered the model last year, led by finance chief Barry McCarthy, who was previously CFO at Netflix. But Gurley and Benchmark weren’t paying tremendously close attention — the firm was one of the biggest backers of Uber and, until July, held a board seat at the often embattled ride-hailing company.
In June, Slack became the second company to go the direct listing route, and that’s when Gurley said he started tuning in. Big IPOs were popping like never before, with Beyond Meat surging 163% in its IPO in May. Gurley noticed the giveaways were getting fatter, so he started studying direct listings and talking to McCarthy.
One big takeaway: There’s no technical reason why companies can’t list themselves. The technology already exists. Companies can essentially plug right into the stock exchanges, and the share price gets determined by a standard market-matching process.
“Almost every other financial asset (the entire bond market) uses market based pricing,” Gurley texted.
Then there are the numbers. Jay Ritter, an IPO expert and business professor at the University of Florida, provided Gurley with data showing that the most dominant banks, Goldman Sachs and Morgan Stanley, have underpriced deals the most — 33.5% and 29.2%, respectively — over the past decade. From 1980 to 2018, underpriced deals cost companies $165.4 billion. So far in 2019, that figure is about $6 billion.
“It’s getting worse,” Gurley said. And there’s a simple reason for it.
Investment banks have a business incentive to give buyers — mutual fund companies and big hedge funds — a deal so that they can count on those investors for future, perhaps less sexy, offerings. Adding up the fees, the underpricing and the discounted shares purchased by underwriters, companies are paying over 40% for the capital they raise. And for that, they get some positive marketing and a trading floor celebration with confetti.
Chamath Palihapitiya, a venture investor and Slack board member, said on CNBC last month after Gurley’s interview that the cost of capital for high-growth tech IPOs is higher than it is for “North Korea or Iran or Venezuela.”
Leading up to this week’s event, Gurley said he lined up 25 top venture firms to support it. He met with Sequoia Capital’s Mike Moritz, an early backer of Google, Yahoo and PayPal. He even spent time with people at Andreessen Horowitz — a humorous twist given that Marc Andreessen once said about Gurley, “I can’t stand him. If you’ve seen ‘Seinfeld,’ Bill Gurley is my Newman.” (Seinfeld’s antagonist.)
The result of his VC meetings: “It was financially supported by all of them,” Gurley said.
The direct listing model still faces a number of challenges before it can begin taking real market share from IPOs.
For starters, in a direct listing, there’s currently no way to raise cash — the primary reason that many companies go public. As it’s set up, existing shareholders can automatically sell stock on the open market but the company doesn’t issue new shares.
Gurley said that the current workaround is to raise a pre-listing round using a term sheet that law firm Latham & Watkins has put together. He said that 40 late-stage firms, including the big private equity shops and money managers already doing private rounds, have shown interest in participating.
Another hurdle is inertia. The IPO process, flawed as it may be, has proven to work for many decades. Spotify and Slack are the only two notable direct listings so far, and Airbnb is expected to take that route next year. All three of those companies have well-known brands and have seen enough secondary sales of their shares to establish a rough market price. There aren’t many other companies in the IPO pipeline with those characteristics.
Also, nobody is going to celebrate the performance of Spotify and Slack on the public markets. Spotify is trading 12% below its reference price from last year, and Slack is about 4% off its $26 reference price, falling with the broader tech market. The companies avoided dilution, keeping more stock for founders and employees, but it’s pretty clear that they were fully valued, perhaps overvalued, by private investors.
Still, Gurley said that he’s heard from a handful of founders who say they plan to pursue a direct listing when the time comes. The teams from Spotify and Slack are offering up their “how to” advice, and he forwarded two emails, one from a venture capitalist and another from a founder (CNBC agreed to not use their names), pointing to the momentum behind the movement.
“It was eye-opening and stunning actually,” wrote the founder. Most illuminating “was the allocations being guided to friends instead of the highest bidders. That actually seems criminal / deceitful let alone crazy.”