Four Key Metrics Pre-IPO Investors Often Overlook
By Lior Ronen
Founder, Finro Financial Consulting
2019 is shaping up to be a banner year for high profile tech IPOs. So far, Lyft, Pinterest, Uber, Zoom, Slack, and Chewy have gone public. Airbnb is expected to join them soon. WeWork is positioned for an IPO later this year. Some 2019 IPOs experienced a 50% or greater rise in the stock price on the first day of trading. Some, like Uber and Lyft, didn’t fare as well.
It’s easy to get caught up in euphoria when the IPO market is hot, and easy to forget that markets fall much faster than they rise. The hot IPO window today could shut tight tomorrow. That’s why we’re seeing a flurry of IPOs, and investors looking to get a piece of a pre-IPO company that could be the next unicorn (privately help company valued at $1 billion or more, poised for propulsive growth).
When considering an investment in a pre-IPO company, due diligence is obviously required. However, no two diligence processes are the same. In 12+ years of analyzing pre-IPO companies, first at Intel and now at Finro, I’ve identified four key metrics that could determine the long-term value of a private company positioning for an IPO or direct listing (offering shares directly to the public without an investment banker, as Slack did last month).
1. Value/ Revenue: When investing in early to mid-stage tech companies many investors ignore the Value/Revenue ratio (i.e. the traditional EV/ Sales ratio). Today, most of the information on public companies is accessible. While it’s difficult to find this metric for a pre-IPO company, this ratio could provide valuable insight into whether the company generates enough revenue for its size, compared to its peers. In WeWork’s case, the company has a significantly high Value/Revenue ratio compared to other players in the co-working niche, which implies that either previous valuations were too high or the company doesn’t generate enough revenue.
2. Off-Balance Sheet Liabilities: This is often considered as a boring technical accounting topic that’s not relevant for tech investing. I find that items such operating leases, legal proceeds, long-terms contracts with suppliers or investors and swap contracts are a few examples that could be found in a “deep” due diligence, and usually not considered when analyzing a company at a high level, or only with focus on top line performance.
3. Economic Moat: When investing in a business in any industry it’s imperative to understand whether it has an economic moat that could help the business maintain its competitive advantage. This moat could be either a unique knowledge, regulatory approval, patents, or a solid relationship with a game changing client or investor. For example, Scoot, was a tremendous small company in the crowded market of electric shared scooter. It had one significant asset that gave it a competitive advantage over other scooter companies: It had one of the two licenses given to scooter companies to operate in San Francisco. Bird, the electric scooter market leader, just acquired Scoot to benefit from this geo-specific advantage in a major U.S. city.
4. Employees and Clients Satisfaction: In many cases investors in pre-IPO companies focus on the phenomenal idea, solution or technology, its top-line growth rates, or different ratios and buzzwords like CAC,LTV and MRR. These indicators can highlight how the company is doing financially. A scan of company review sites where employees and former employees post comments can also show you a lot. Social media and on-line searches can provide another layer of ratification towards the market acceptance of the product or solution the company is offering. Or, you may find systemic issues with how the company treats employees, partners, or suppliers that could color how you see this prospective investment.
What has fascinating me about the tech market since the beginning of my career is its dynamic nature. The market is always in flux, the next great thing is just around the corner. Digging deep into the DNA of a company – from a financial, contextual and human perspective - gives you a certain comfort level in making important investment decisions. It’s worth taking the time to do that.