In recent weeks, Arm, Instacart, and Klaviyo priced their IPOs, marking some of the first notable IPOs by technology companies in the past 18 months. As macroeconomic conditions and market sentiment appear to stabilize, whispers of IPO potential have started to emanate from the boardrooms of late-stage private companies, underwriters, and venture funds. After an 18-month quiet period, there are finally signs of life. Are IPOs back and will they be here to stay?

Can Marquee Deals Reinvigorate the Market?

Investor demand seems strong. Names of prominent investors were splashed across the filings for Arm, Instacart, and Klaviyo, and although each has experienced some volatility in trading, all priced at or above the top end of their ranges. Instacart and Klaviyo also raised their price ranges while on the road. What were their keys to success?

Built for Today (and for Tomorrow)

Higher costs of capital, uncertainty in the private financing markets, and decreased investor risk appetite have created powerful incentives driving companies to adopt cost-cutting measures and prioritize profitability. Companies seeking an IPO in this market may no longer be able to sell growth alone. The result has been a pipeline of pre-IPO companies with strong fundamentals and robust growth prospects.

• Focus on Profitability
  These recent IPOs suggest that company profitability, or a path to profitability, may be key for near-term IPOs. Each of these companies had achieved positive GAAP net income in their most recent period, with Arm and Instacart reporting significant profits over consecutive periods. Where applicable, issuers should consider holistic profitability disclosure beyond simple numbers—for example, Instacart’s MD&A discusses its profitability philosophy and strategy at length.
• Revenue Growth Is Still Here
  While profitability is certainly an important theme in the current market, topline growth will likely retain its traditional importance to investors. Instacart and Klaviyo both illustrate that it is possible to prioritize profitability while maintaining robust revenue growth—in 1H2023, Instacart’s revenue grew 31 percent year-over-year and Klaviyo’s grew 56.5 percent year-over-year. Though Arm reported a slight revenue decline in recent periods, its revenue grew 33 percent between 2021 and 2022. Issuers should further expect investors to carefully evaluate the key drivers of revenue growth. For Instacart, the breakdown of revenue growth was reported to be a significant topic of investor interest, as growth in advertising revenue significantly outpaced growth in its core grocery business in recent periods.
• What Goes Up Must Come Down
  One of the biggest questions facing the IPO market has been valuation. Although the pricing of these IPOs suggests that market upside remains, early signs suggest that valuations have not rebounded to their pandemic-era peaks. Implied IPO valuations of Instacart and Arm reflected decreases of approximately 75 percent and 15 percent, respectively, from previously reported transactions, while Klaviyo’s implied valuation was roughly in line with its previous financing. Companies seeking to access capital markets today—and particularly their late-stage lead investors—may need to be prepared to do so at a discount to their last valuations.

Friends in High Places

After 18 months of “wait and see,” votes of confidence from key investors may help to coax more reluctant investors back into the markets. Arm, Instacart, and Klaviyo each secured indications of interest from headline investors—a collective list that included AllianceBernstein, BlackRock, and Sequoia, as well as strategic investors like Google, Intel, Nvidia, and Samsung. While Klaviyo and Arm’s indications of interest are in line with historical trends for technology IPOs (around 15 percent of the total offering), Instacart received indications of interest to purchase up to 61 percent of its total offering. In addition, PepsiCo agreed to purchase $175 million of Instacart’s Series A preferred stock in a private placement concurrent with Instacart’s IPO, which notably is senior to its common stock upon a liquidation and incorporates a minimum 5 percent return that compounds annually. Companies that are able to attract top investors may be able to launch their deals with momentum, price them higher, and promote stock price stabilization post-IPO. In light of these trends, “testing-the-waters” meetings and concurrent private placement efforts will likely take on enhanced significance in the current market.

Show ME the Money

Creative, variable approaches to lock-ups may be here to stay. Employees of Instacart and Klaviyo have a path to liquidity that is a little quicker than the historical 180-day norm. Instacart’s lock-up allows current employees to sell up to 35 percent of their stock as early as November, so long as the stock is trading up at least 20 percent from the IPO price for a period of time. Similarly, Klaviyo’s lock-up structure allows current employees, former employees, and certain non-affiliate stockholders to sell up to 20 percent of their stock as early as November, so long as the stock is up at least 30 percent from the IPO price for a period of time. Both lock-up structures also provide for a full release of the lock-up after earnings are announced for the second completed quarter post-IPO (sometimes referred to as an “anti-front running provision”), preventing a situation where the lock-up comes off during a quarterly blackout period—when a company’s affiliates and employees are prohibited from trading under its insider trading policy. Neither Instacart nor Klaviyo included a “Day 1” release provision—first seen in 2020 and used by some large technology issuers during the pandemic-era boom—under which employees and other stockholders are permitted to sell a portion of their shares on the first day of trading, although a portion of each offering consisted of sales to the underwriters by select stockholders. Arm’s IPO was purely secondary and allowed its sole shareholder, SoftBank, to sell a portion of its shares; however, SoftBank remained subject to a 180-day lock-up with respect to its other shares and Arm’s employee equity was structured only to vest 180 days following its IPO (functionally locking employees up for 180 days).

Each of these companies was a high-valuation, high-revenue unicorn. While these transactions have offered helpful insight into what we might expect from the market going forward, it remains to be seen whether these transactions are the outliers or a promise of more to come.

Should I Stay or Should I Go Now?

Following the successful IPOs of Arm, Instacart, and Klaviyo, companies with long-shelved IPO plans, as well as those considering an IPO for the first time, may be in a position to go public later this year or sometime early next year. But should they? Companies exploring an IPO should consider the following potential benefits and drawbacks:

Potential Benefits

• Greater Access to the Financial Markets
  The most obvious benefit of a traditional IPO is the capital raised in the offering, which can be used for growth. Following an IPO, a company’s opportunities for future access to capital broaden as well. These factors may be especially important as the market for late-stage venture capital financings remains anemic, with many growth-stage companies navigating fewer term sheets, lower prices, and less favorable terms than their prior financings, and many growth-stage venture funds contending with significant markdowns in their portfolios and a need to finance existing portfolio companies for longer.
• Motivating Employees
  Although equity has historically been an important component of technology companies’ compensation packages, significant inflation and related interest rate increases are likely enhancing the value of employee liquidity. An IPO creates an active trading market that allows management and employees to monetize their shares more easily. In the current monetary environment, employees and prospective employees may be more cash-hungry than in recent periods and may place greater emphasis on near-term liquidity. A liquid trading market will allow public companies to bridge that gap without using cash from their balance sheet, which may put them at a competitive advantage in recruiting and retention.
  
  If companies are not prepared to create a liquid trading market by going public, they may find themselves compelled to generate other pathways to liquidity, especially if they have stock options and RSUs nearing their expiration dates. Many companies that were aiming to go public around the time the IPO market took a downturn in early 2022 are starting to bump up against these windows. Expiring equity awards are most likely to affect the earliest employees, who are often a company’s most senior and integral team members. In one recent high-profile example, Stripe raised a new $6.5 billion Series I private financing round to provide liquidity to current and former employees and address employee withholding tax obligations related to equity awards. If a company is not in a position to fund employee liquidity or tax obligations itself, going public is one way it can efficiently motivate, reward, and retain talented employees.
• Investor Liquidity
  The long IPO hiatus has also disrupted investors’ expectations for achieving liquidity. As venture funds that have been long-term investors in late-stage companies near the ends of their cycles, these funds have a need to return capital to their investors, who are eager to book profits on old investments or reallocate capital into other sectors, including debt markets that are providing significantly greater returns than in recent years. And while distributions of private company stock to a fund’s limited partners are rare, distributions of public company stock are comparatively straightforward. An IPO can also offer private equity buyers a pathway to achieve partial near-term liquidity while retaining exposure to future upside in a portfolio company’s business. With valuations continuing to struggle, that may be a more attractive exit to many such buyers than selling their portfolio companies outright.
• Increase Credibility and Brand Recognition
  An IPO can create publicity, brand awareness, and prestige for a company. Public companies have instant credibility with employees, customers, and partners. In addition, a company may gain access to many deep-pocketed investors who do not invest in private companies. An established public market for a company’s stock also provides the advantages of a readily ascertainable market value and liquidity, which may make a company’s stock a more attractive form of consideration to targets in M&A transactions.

Potential Drawbacks

• Reporting Cycles and the Focus on the Short-Term
  Because a company’s stock price often fluctuates in response to short-term financial results, management may face more pressure to make decisions that favorably affect short-term results at the expense of long-term strategic goals. Activist investors are increasingly putting pressure on public technology companies to make changes of both an operational nature, such as management changes, reductions in force, or dividends/share buybacks, and a strategic nature, such as launching a formal sale process or divesting a line of business.
• SEC Regulation
  Another major burden of being a public company is the significant disclosure obligations imposed by the U.S. federal securities laws. The required disclosures include extensive information concerning the company’s business and finances, as well as detailed information relating to executive compensation and transactions with insiders. SEC regulations require disclosure even when such disclosure may negatively impact the company’s business. Directors, certain officers, and certain significant stockholders will be required to file reports with the SEC describing their ownership of, and transactions in, the company’s securities. Additionally, there are a number of new regulatory requirements that have been implemented by the SEC and many more on the horizon. In the past 18 months, the SEC has adopted new rules around cybersecurity, share repurchases, insider trading plans, and executive compensation (specifically, “pay versus performance” disclosure and the required adoption of clawback policies). In the next year, the SEC expects to issue rules around climate change disclosure as well as beneficial ownership reporting, board diversity, and human capital management. Pre-public and newly public companies should expect compliance with these regulations to demand significant management attention; expansion within a company’s legal, accounting, and finance organizations; and a corresponding increase in related general and administrative costs.
• Legal Exposure
  The company and its directors and officers will be subject to potential liability under the federal securities laws for material misstatements or omissions in the IPO registration statement as well as in periodic reports, stockholder communications, press releases, and other public disclosures. This potential liability is a very real risk, especially for young, rapidly growing companies whose operating results can fluctuate significantly from quarter to quarter and year to year. These fluctuations often cause a company to fail to meet the expectations of stock analysts and investors, resulting in a decline in the company’s stock price.

What Can We Do Now?

An IPO is a significant, months-long undertaking. Klaviyo had the shortest registration process of the three companies discussed here, at four months following its initial submission to the SEC. With the IPO market showing signs of a resurgence, companies seeking to ensure they are ready when the window opens should take the following steps now:

Business and “Street” Readiness

Unlike during the earlier pandemic-era IPO window where the economic focus was largely on a company’s addressable market and growth prospects, companies should strive to demonstrate a fully operational commercial engine to be marketable at desired valuation levels. In addition to a clear path to profitability like recent IPOs have demonstrated, investors will be focused on other non-growth metrics like margins and free cash flow.

To meet these expectations, many late-stage private companies have begun prioritizing headcount efficiencies, investments with near-term ROI, and general cost-cutting measures. Investors will also be looking for companies to have dependable external infrastructure, including reliable and trustworthy suppliers and, where applicable, a resilient supply chain. Companies should establish procedures for robust revenue, expense, and operating results forecasting, with the key being to meet or slightly exceed expectations, as missing forecasts can lead to disproportionate stock price impacts.

Another layer of commercial preparation is ensuring that companies’ management and investor relations teams are ready to “talk to the street”; in other words, that they are equipped to convey the company’s business narrative and long-term vision and brand effectively and consistently. Companies may even consider holding practice earnings calls with management, board members, and key stockholders.

Selecting Key Metrics

Key metrics help investors see the business through the eyes of management and facilitate comparisons with competitors. They are an important disclosure in the IPO and are equally important post-IPO. Companies should focus on what matters to them and not allow the “analysts” or the “market” to dictate the metrics disclosure. Key metrics typically capture concepts such as scale, customer engagement/monetization, customer retention, and other financial highlights. Companies should assess whether their metrics reflect the drivers of the business or could be used to explain the results of operations. Does management use these metrics to operate the business, and will these metrics continue to reflect the business in the future? Could these metrics turn negative in the near future or be misleading? Can the company accurately calculate these metrics over time, both historically and moving forward? For example, has the methodology used to calculate a key metric changed over time? Companies should start thinking about these considerations early and begin formulating their metrics well in advance of their IPO.

Investor Education

As the market begins to pick up, companies should keep investor education top of mind. Companies that are further removed from an IPO often participate in non-deal roadshows to educate investors about the company without any specific mention of a contemplated offering. Leading up to an IPO, companies and underwriters participate in “testing-the-waters” meetings with certain investors to further educate investors on the company’s business, gauge interest in a contemplated offering, and help the company to refine its messaging for the IPO roadshow. Unsurprisingly, it has been noted that the recent technology IPOs have featured extensive “testing-the-waters” meetings to improve the chances of a successful IPO. Companies, including those that put their IPOs on hold in early 2022, will want to update investors on their business early and often—whether that’s reigniting “testing-the-waters” meetings for a near-term IPO or initiating non-deal roadshows if an IPO is further down the road.

Enhancing Controls and Systems

Being ready to go—and stay—public involves transformation across many functional and operational areas, and it requires a major contribution from many participants.

Inadequate controls and systems, specifically with regard to the compilation of public-company-compliant financial statements and processes, disclosure controls, enterprise resource planning, human resources information systems, and equity administration, were commonly behind process delays in the pandemic-era IPO boom, as well as costly and embarrassing compliance issues post-IPO. Companies should make it a priority to begin assessing needs and gaps early, as hiring the right people and implementing appropriate controls and systems are lengthy processes. Companies may also consider engaging consultants to assess any gaps and recommend remediation, particularly if management has limited experience operating public companies.

Consider Post-IPO Governance Structure

Public companies are subject to extensive corporate governance standards imposed by the SEC and stock exchanges, which prescribe the formation of specific board committees, establish multilayered director standards, and require policies impacting numerous areas of a company’s operations. Although transitional “phase-in” periods apply to some of these requirements, companies planning for an IPO should consider assessing their board’s compliance with these standards, recruiting additional directors to fill identified gaps, and beginning to formalize governance processes and policies well in advance of an IPO. As proxy advisory firms moved to curb the number of boards on which public company directors serve, new board diversity requirements were implemented, and the number of public technology companies exploded during the pandemic, experienced public company directors were in high demand. Many companies found that it took time to recruit directors that not only had the required qualifications, but were also a good fit from industry, cultural, and/or interpersonal perspectives. When the IPO market returns in earnest, companies may find it more time-consuming or challenging to identify director candidates that check all their boxes.

The pandemic-era IPO boom also saw a significant expansion in the number of dual- and multi-class voting structures among technology companies at IPO. Such structures are often implemented to give existing stockholders, including founders or other executives, more control, and can be highly customized and entail significant involvement from founders, key investors, and their respective advisors. Given the complexity and multilateral nature of these negotiations, companies interested in exploring dual- or multi-class structures should consider getting an early start.

Monitoring Legal Compliance

While becoming a public company entails an extensive set of rules and regulations, staying private longer has its own set of legal challenges, including:

• Rule 701
  In light of extended IPO timelines, companies must remain vigilant about compliance with Rule 701, the primary U.S. federal securities law exemption for employee equity. Companies that remain private longer are likely to have to provide extensive disclosure packets to employees, containing much of the same financial and risk factor disclosure as would be included in a public company’s reports. Moreover, companies with significant employee equity compensation programs will need to monitor compliance with hard caps on issuances under Rule 701 (typically 15 percent of the issuer’s total assets or 15 percent of the class of securities outstanding, excluding other Rule 701 securities, in a 12-month period), which can be particularly challenging where a company pursues stock option repricings, grants replacements for expiring awards, or conducts company-wide “refresh grants.”
• Section 12(g)
  Companies seeking to remain private must continue to be mindful to monitor and avoid triggering Section 12(g) of the Securities Exchange Act, which requires a company to go public if its total assets exceed $10 million and a class of its securities is held by either 2,000 persons or 500 persons that are not accredited investors. Although securities held by persons who received such securities under Rule 701 (e.g., most employees who receive equity awards) are excluded from these counts, the exclusion does not extend to transferees of their securities. Accordingly, companies without blanket transfer restrictions, companies with active secondary markets, and companies that facilitate employee liquidity through secondary sales must be particularly wary of Section 12(g).

Considerations for Financings Leading Up to IPO

Companies contemplating a private funding round prior to an IPO should also keep in mind deal terms that could be a barrier to an IPO, such as automatic conversion provisions that depend on achieving a certain level of proceeds, minimum share price, or both in connection with an IPO. In addition, companies should be particularly mindful of protective provisions or other consent rights which may give pre-IPO investors the ability to block an IPO. In some cases, financing documents may also contain an explicit “IPO Conversion Ratchet,” whereby if the IPO price does not reach a threshold, the preferred conversion ratio is automatically adjusted so the target is met. If feasible, companies should attempt to address these issues in advance of the IPO process.

Conclusion

We approach the remainder of 2023 and 2024 with cautious optimism. While there is no doubt that the state of the IPO market over the coming months will be determined primarily by macroeconomic factors and how the recent IPO companies’ stock trade, the other considerations described above will also play an important part in a company’s decision of whether to move forward with IPO plans and their ultimate success. If it is the right time for your company to go public, we encourage you to take action to maximize your chance of taking full advantage of your optimal IPO window when it opens up.

For any questions or additional information about the above considerations, please contact a member of the capital markets practice at Wilson Sonsini.

Partners Allison Spinner, Michael Nordtvedt, Rezwan Pavri, Shannon Delahaye, and Andrew Gillman and associates Cody Gaynor and Ari Goldberg contributed to the preparation of this advisory.