The Next IPO Class Is Still Private

If you have worked inside a company on its way to a listing, you know the IPO is not the beginning of the story. By the time the bell rings, the company has usually found its market, built its second and third products and learned to sell to large customers. Most of that work happened while it was private, and most of the value it created along the way went to the people who owned it then.

The long middle

Companies now stay private far longer than they did a generation ago, and they reach a scale in private hands that used to belong to public markets. That leaves a long middle stretch, after the venture years and before the listing, that public investors can't reach and most private investors only see one company at a time.

That stretch is where we invest.

How a private company is priced

Operators see private pricing from the inside, and it is messier than a stock quote. There are at least three prices for the same company at any time.

The primary round price is what new investors pay for preferred stock. It comes with terms: liquidation preferences, protective provisions and sometimes structure that a headline valuation doesn't show. Two rounds at the same price can be worth very different things.

The secondary price is what common stock or older preferred trades for between existing holders and new buyers. Trades are thin, information is uneven and the company often has a right of first refusal. A single trade tells you less than it seems to.

The 409A value is what the board sets for option grants. Employees know it well. It is built to be conservative and it usually sits below the preferred price.

None of these is the true value on its own. Our job is to work out what a share is worth on the day we buy it, compare that with the price we are actually paying and walk away when the gap is in the wrong direction. I have spent nearly ten years buying and selling private shares directly, and the price we pay is still the decision we spend the most time on.

What we look for

We start from a short list. At any given time it is the 100 largest U.S. private technology companies with tier 1 venture backing and more than $100 million in trailing-twelve-month revenue. A company has to be real before it is interesting.

From that list we aim to own about 30. Every position goes to our investment committee, and each member scores it from 1 to 4. A company needs an average of 3.0 to pass. Most don't.

We look for the things an experienced operator would check first: customers who expand once they are in, a business that funds more of itself each year, a management team that has been through a hard quarter and a capital structure that leaves room for common holders. We hold a position for one to three years as a target, with a listing or a sale as the usual way out.

Questions worth asking about any private company

• How much of last year's revenue came from customers who were already there the year before?
• What does the full preference stack look like, and where does common stock sit in it?
• Who set the last price, and how many shares changed hands at it?
• What would the company need to show a public investor that it can't show today?
• If the listing slips two years, what does the company do?

If you have been through a listing and want to compare notes on the companies coming next, we would like to hear from you. Our current fund, Private Tech 30 Fund II, is open to qualified purchasers.