Earlier this week I was talking to a group of investment bankers about the process of going public. In particular I was drilling in on the much vaunted need for revenue visibility as a basis for giving quarterly guidance. Every company that is thinking about going public hears this and it becomes an obsession for the team and the board.
Why do you need revenue predictability? Because you need to give guidance. Why do you need to give guidance? Because the market expects it. Why does the market expect it? Because everyone else is giving guidance. This is a great example of how rational expectations by all players involved can land you in a bad equilibrium, not unlike the prisoner’s dilemma. Everyone is on a short term, quarter-by-quarter treadmill and nobody can get off, because the first one to get off will get punished. But collectively we would all be better off if companies were focused on the long run.
When do expectations get set? During the process of going public. So what further proliferates short term focus is that new companies going public and adhering to the same expectations do nothing to break us free from this bad equilibrium.
But does it really have to be that way? No. There are clear examples of companies that break the mold. First, there are entire categories of public companies, such as drug development, that don’t have any revenues. There everyone is willing to accept that these companies are engaged in a more long term pursuit. Second, even within the Internet technology world there are at least two companies that seem to care very little about what analysts think: Amazon and Google. Both have been investing heavily in big visions for the future. And both have done incredibly well.
When you bring that up with investment bankers, they inevitably say dismissively “well, that’s Amazon” (implying, but not saying, “and your company is no Amazon”). That of course ignores that Amazon wasn’t the Amazon we know today either when it went public but rather a tiny e-commerce site with minimal revenues.
Another pernicious argument by bankers is the following: “if you don’t give guidance, analysts will do it without you and that will be worse for you.” There are several flaws with this. First, if you miss your own guidance you will be punished far worse than if you miss analyst’s guidance that you didn’t establish. Second, the real freedom comes after you have had a correction and demonstrated that the company is not deterred by that from pursuing its vision and that life in fact does go on.
I am convinced that any one company going public can break this cycle for itself. How? First, by aligning its existing investors and board members behind a long term vision. Second, by selling that vision to public market investors from the very first meetings. But it all starts with accepting that out of the gate this approach will not maximize valuation and may result in a some setbacks in stock price along the way.
What would you rather have though: an initially high stock price and be on the short term treadmill or a slightly lower initial price (cf Google) and freedom to pursue a longterm vision. This seems like a no brainer to me, but it takes great personal conviction to pursue a path that’s outside the currently established rational expectation equilibrium. People will consider you to be irrational and maybe just plain weird. Small price to pay in my book.
