It is a truth universally acknowledged that investors in tech companies get the best exit valuations in IPOs. This has been accepted as axiomatic as long as I have been practicing law. As far as I can tell, when public companies get acquired the buyer usually pays a premium over the public valuation. This premium, often referred to as a control premium, suggests that there is “extra” value in not being public. If companies typically command a premium when control is sold, why are they not valued at a discount when they go public and control becomes diffuse? I can imagine a number of rationalizations for this anomaly (that companies command a premium when they go public and another premium when they go private), one is that these companies may have been public for a while and their public values may have sunk considerably from the halcyon days following the IPO.

But the point I want to get to is that you might think that selling a private company would produce a bigger premium than taking it public. The seller could jump all the way to the final control premium price. Another thought is that most venture financed companies that have gone public in the past ten years have not performed well. Obviously we are in the Great Recession, but this observation was, I think, widely thought to be true even before the Great Recession.

One possible explanation, among many, is that IPOs were hyped and sold rather than researched and bought by thoughtful investors. In other words, as Healy Jones said in his blog Startable some time ago, the public was sold a lot of stock that really did not have good investment characteristics (it was a load of crap and people lost a lot of money investing in it). Of course, there were and are a few stars (Google for one). Having said all this, it may be (perhaps certainly is) true that private buyers such as Google, Microsoft, AOL, Zimmer, etc. are just more discerning and more able to accurately value acquisition candidates than public investors.

If you agree with the thought that most of the venture backed companies that have had IPOs should not be public, then you probably agree that the IPO market should not return to pre-Great Recession norms. How much below these norms the IPO market should/will return to is impossible to tell. But, if the so-called venture model is dependent to a material extent on a robust IPO market which in turn is dependent upon investors making poor decisions, then there really is something wrong with the venture model. The venture model needs to work based upon returns obtained from sophisticated private buyers – who seem to pay less than the public.