A wave of innovation is transforming IPOs. 3 insiders lay out what changes are next – and what could bring it all crashing down.

By Dakin Campbell

The IPO market is in the midst of an unprecedented run.

Bankers, lawyers and venture capitalists involved in the market don’t see that coming to an end anytime soon, according to the comments of three who recently spoke at an Insider webinar.

“We’ve been talking about a tech IPO supercycle for three years now, and we’re still in it,” Kim Posnett, the global head of Goldman Sachs’ investment banking services business, said during the virtual event. “I believe you’ll still see that in 2021. So I believe that that tech IPO supercycle is accelerating.”

In each of the last three years, more than a dozen companies valued at $1 billion or more tapped the public markets, according to Posnett. That’s up from an average of one to two each year.

Last year, 218 companies raised $78 billion in the public markets, according to IPO experts Renaissance Capital. Both stats are the best for the market since 2014. And last year’s numbers don’t include the blank-check companies that have taken the market by storm.

Amid the uptick in volumes and deal size, startups and their advisors are innovating around the process like never before. They’re playing around with the traditional 180-day lockups, and introducing auction elements and allowing employees to sell earlier than usual in some cases, and that’s just within the traditional IPO process.

A wave of innovation in going public

Direct listings offer startups a second way to go public, and late last year, the Securities and Exchange Commission said that firms could now raise capital with the approach. Blank-check companies have emerged as a legitimate third option.

“I tell the junior attorneys who work with me that there’s never been a better time to be a capital markets lawyer,” Latham & Watkins attorney Greg Rodgers said at the same event. “We’re seeing very interesting things on dual class stock and lock up releases, which is making the products less one-size-fits-all.”

One recent development is called a hybrid IPO, which borrows elements from an auction process to set the price but allows the company to retain an ability to allocate the shares to loyal investors. Gaming startup Unity used the technique in September, and Airbnb and DoorDash followed with their own versions in mid-December.

The process didn’t prevent the first-day pop in the stock price that has become a flash point among some market participants, but it did deliver more data to the companies.

Insider previously reported that one reason Airbnb and DoorDash stocks popped is because the companies ultimately prioritized the make up of their shareholder base over getting every last dollar by pushing up the price.

“It provides transparency, but it doesn’t change the last decision where our clients decide how much price they want to take, versus curating a shareholder base,” Posnett said. “And so what we’ve seen is once they get to a certain price that they’re comfortable with, and that price changes per client, issuers have turned to shareholder base curation and prioritizing that.”

Posnett said Goldman is finding that clients appreciate the transparency.

“I do think there’s increasing enthusiasm to use it in IPOs for people who choose to go the IPO route,” she said.

Direct listings get a new twist, but there’s still work to be done behind the scenes

Since Spotify pioneered the direct listing as a way for tech startups to go public, there have been four such transactions. All were used by companies that didn’t need to raise capital.

In late December, the SEC approved a New York Stock Exchange rule change that now allows companies to raise capital at the same time they go public using a direct listing. Some market practitioners think that the technique will eventually replace the traditional IPO.

Rodgers cautioned that it will still take a courageous company to work out all the kinks of the process.

“There is some wood that remains to be chopped there,” he said. “The stock exchange rule is only one component of the total rulemaking package. Some innovative company is going to have to work through the minutiae of how some of the rules apply with both the office of corporation finance and trading and markets at the SEC itself.”

Mitchell Green, founder of growth-stage VC Lead Edge Capital, said he sees blank-check firms, or special purpose acquisition companies, serving the needs of three types of companies: concept companies without much revenue but big dreams, more mature private-equity backed companies with real revenue but lower growth rates, and corporate spin-outs.

“In the first bucket, you can raise capital where, in the private markets, that may have been even harder,” he said at the same event. “Second bucket, I think you can go to the private equity firm and offer them an exact price that you’re doing the deal at with certainty, where they can also get a lot of liquidity.”

In the past, Green said, it’s been more difficult for private-equity firms to get liquidity by pursuing IPOs. That’s changing, he said, citing the upcoming IPO for dating app Bumble, in which his firm is an investor.

Bankers are starting to think about retail interest differently

One factor that hangs over every popular IPO in this environment is the influence of the retail investor. Airbnb’s stock popped on its first day of trading, in part, because of huge demand from retail investors, Insider previously reported.

Posnett said that while Goldman doesn’t often factor in retail interest when giving advice to clients, that’s starting to change.

“When we think about giving advice to our IPO clients around marketing their IPO, pricing their IPO, it’s not wrapped around retail, it’s more wrapped around market sentiment and investor sentiment,” she said. “Now, having said that, retail buying has been a factor in these IPO. There’s no doubt about that.”

The bank is beginning to look into how it can better incorporate retail interest into the IPO plans. Posnett declined to offer specifics.

Robinhood, the retail brokerage startup that’s pursuing an IPO this year, has been considering selling some portion of its shares to customers of its trading app, Bloomberg reported. Posnett didn’t mention the company by name.

“I do think that you will see more innovation around that in the coming years,” she said. “We’re talking a lot and thinking a lot about it and so more to come. But it is a focus of ours.”

Chatter about regulation, inflation, and other risks to the IPO euphoria

What will it take to stop the bull market?

With all the excitement over the current state of the market, the panelists did take some time to talk about what may bring it to an early end.

Green, adding a quick caveat that he isn’t an expert in macroeconomics, cited two catalysts that came to his mind: over-rational exuberance, or if everyone turns bullish all at once, or an unexpected increase in inflationary pressures that might lead policymakers to raise interest rates.

“The whiff of inflation is going to scare people to think rates are going to go up,” which will send stocks down, Green said. “I don’t think they’re going to go down 70%. It’s not the Internet bubble, these are real companies, but you could see these things come down 30%.”

Posnett said her chief worry is that a flood of companies come on the public markets that aren’t ready for it, and lead investors to take losses.

“What we all know is that the equity market’s ebb and flow over time,” she said. “There are some great companies right now that are fundamentally changing industries through technology and innovation, and investors want to own them,” she said, adding “the flip side is I think that if you see a lot of companies come public that are not ready to be public companies, that could be damaging to the market.”

Rodgers agreed, though his worry was more about the second-order effects of bad companies and investor losses: increasing regulation.

“A round of overregulation could be bad,” he said, citing the Enron bankruptcy and the 2002 advent of the Sarbanes-Oxley Act. “That really chilled the US markets for a while. So, to Kim’s point, if we see companies go public earlier than they should, and then they flame out, and people lose 401k savings, that is bad for many reasons. But one of which is it would likely drive regulation.”