Big IPO valuations don’t sneak up on small companies.
The idea that any startup could IPO valued at a $100 billion was ludicrous, until Facebook. Several other IPOs and buyouts followed at similar eye-watering valuations. Skeptics, and I started out in this camp, see these events as symptoms of a dangerous bubble.
Then you hear Jos Schmitt, CEO of Aequitas, make a sound argument for Facebook’s extraordinary valuation.
Even more surprising, Schmitt makes a compelling case for why Canadian startups are chronically undervalued, and how to change that.
Schmitt was Michael Cayely’s guest for an April 14 2014, Startup Grind Toronto fireside chat. Once again Willdeboer Dellelce hosted in fine style. The Toronto-based law firm is a specialist in startups.
Schmitt has a unique perspective. His bio says “25 years of experience in the financial services industry with expertise in market infrastructure, across asset classes and across geographies.”
In concrete terms, Schmitt knows stocks, bonds, and other interest-paying investments. He has developed deep insight into why people trade them, how the trading markets work and what tools they use to do it – wherever in the world that people trade.
In June of 2013 Schmitt took on the role of CEO of Aequitas, a company dedicated to creating a new Canadian stock exchange. More importantly, Aequitas is creating a new platform for trading private securities focused on improving the liquidity of small- and mid-cap companies.
Ask Schmitt what holds back Canadian tech startups and he acknowledges the usual suspects. Talent-finance-revenue are indeed problems, well documented by IT Business Canada in its ongoing coverage of PWCs annual Report on Emerging Canadian Technology Companies.
But Schmitt sees a systemic root cause. “The ecosystem is not working well. It’s not a lack of smart people, good education or people with good ideas. We don’t lack capital in Canada. There’s a lot of it. It’s that it keeps going to other places and not into the world of entrepreneurs.”
Schmitt says there are two important gaps for small- and mid-cap companies. The gaps are in mentoring and liquidity.
“There is still a lack of mentorship, people helping entrepreneurs to find their way in a world which is quite complex. It’s great to be a champion in a certain area (of tech). But how do you fund it? How do you take it to market? How do you develop a distribution channel? How do you acquire clients? How do you manage a company? Lots of items of that type are still missing.”
Schmitt believes there are now a lot of initiatives to address the mentorship gap. Time and persistent execution should close the mentorship gap.
Lack of liquidity, says Schmitt, is still a problem. “There is an enormous funding gap as soon as you get above $2m to $3m. To look at companies in a simple way, you have starting it, building it and growing it. ‘Starting’ is when you define it. ‘Building’ is when you really develop your product and find your first clients. Once you get to ‘grow it’ there is no money in Canada.”
This stunts the growth of companies. That harms entrepreneurs and employees. Governments fail to get a decent return from their investments in education and early-stage tech company supports. It hurts the Canadian economy as a whole.
So, says Schmitt, entrepreneurs are faced with three alternatives. Many choose to “exit very early. Yes, you get a little bit of money out of it. But you miss the enormous opportunity to build a really great company. With all the opportunities it could represent for you as a founder and also for the entire economy in Canada and for employment.
“The second alternative is that people just go to the US and find an investor there. The ecosystem there is much better.” An extreme example is Facebook. Instead of jumping from Series B to IPO, Facebook traded on private markets, and maintained focus and control while building up its valuation.
“The third one (alternative) is that people go public far too early in their life cycle. You should still be focused on growing. Developing your business. Making sure your products are working well.”
When you go public too early, “suddenly you’re exposed to a world where you face quarterly results, enormous reporting needs.”
Companies pay penalties in both the short and long term. Publicly listed small- and mid-caps, says Schmitt, “are probably spending 20% – 30% of their time and cash (on reporting), which is enormous.” If such companies could trade on private markets these costs would plummet to just “a few percentage points.”
In the long term, “you are publicly traded and you don’t have that many investors who are that interested in you,” says Schmitt. “You become a company that trades 500,000 shares a week. No liquidity. No liquidity becomes an orphan company. You need funding afterwards, people will say ‘wait a minute – this is not a liquid company, I’m going to want a discount.’ ”
How does your experience compare with the picture painted by Jos Schmitt?