Editor’s note: Spencer Rascoff is CEO and a director of Zillow Inc. He previously co-founded Hotwire.com, which was sold to Expedia in 2003. Before his consumer Web career, Spencer was a private-equity investor at TPG Capital, and an investment banker at Goldman Sachs, Bear Stearns, and Allen & Company. Follow him on Twitter: @spencerrascoff.
Following the closely watched Facebook IPO, there has been increased scrutiny around the IPO process and a lot of discussion about whether certain companies are ready for public markets.
It’s been a little more than a year since Zillow went public, and I’m regularly asked about our performance relative to other technology companies that have gone public in the past couple of years. Ultimately, I believe the markets recognize and reward companies that execute well. But the road leading to an IPO is a complex one, and every chief executive and board must ask, “Should we go public, and, if so, should we go public now?”
Having watched these events as a former investment banker before becoming a CEO, I believe there are some fundamental milestones and practices every company should meet to be IPO worthy and operate successfully as a public company.
1. Revenue Scale
Companies should be delivering at least $60-$100 million in annual revenue or $15-$25 million in quarterly revenue. Sure, some companies go public with less revenue, but the reason why revenue scale is important to investors is it helps demonstrate that customers are willing to pay for the services the company provides. But it’s not all about revenue (see #2) – as many newly public companies have learned.
Companies should demonstrate at least cash flow or EBITDA profitability – and preferably net income profitability (or be extremely close) in order to be IPO-worthy. It’s important for investors to see that the business can be self-sustaining and cash-flow positive. Repeatedly seeing red on financials does not instill a lot of confidence, regardless of revenue size.
3. Proven Financial Controls
Sarbanes-Oxley changed the playing field, and while companies do not need to be compliant at IPO, they need a clear path to compliance. Companies planning an IPO shouldn’t wait; they need to ensure they have proper financial controls in place. This involves building the right team with the right technology and processes to exert control over your treasury function so you can operate without hiccups. For example, investors don’t look kindly upon a “material weakness” in an IPO prospectus, because it says to investors that the numbers can’t be relied upon. One or two missteps as a public company can cost you years of credibility.
The fourth and fifth requirements are much more difficult, and I think this is where a lot of companies get tripped up.
4. Understanding Business Levers
Company executives must understand the levers of their business. In other words, if you do X, you know that Y will happen. So, for example, if I hire 10 sales people, I can predict what will happen to revenue and costs. If I hire 10 software developers against a major product initiative, I can predict how long it will take to complete and understand how it impacts our P&L. Too often, companies are still learning and developing and have no clue how X will benefit – or hurt – the bottom line. This is understandable for a relatively new startup, but it doesn’t engender confidence in investors of public companies.
5. Ability to Accurately Forecast
Lastly, you need to have a track record of forecasting your future business results with a high degree of certainty for at least several quarters. This point is a direct output of Rule #4, because if companies don’t understand their levers, then it will be next to impossible to forecast their business – which is a critical one for any public company.
The challenge many newly public companies face is they don’t have the history or experience in forecasting and haven’t had to answer to anyone for significant misses. Whether a company outlines guidance or not, there will be expectations for results that the company must manage. In addition, the platform shift from desktop to mobile presents some unique challenges for companies contemplating an IPO, because they need to be able to demonstrate to investors that they can navigate this shift rather than be tripped up by it.
Too often we find companies that are so overqualified on points 1 and 2 (revenue scale and profitability), yet they then get tripped up on points 4 and 5 (understanding the levers of their business and, therefore, forecasting). For executives and investors contemplating a future IPO, I suggest at least evaluating these guideposts for your particular situation.
Remember, it doesn’t have to be a question of if, but when – just make sure you are truly ready.