Social Media IPOs—A Trend to Alter VC Investment?

Posted by | February 28, 2011

I was reading an article by the San Jose Mercury News’ Patrick May recently, titled “IPOs by LinkedIn, Facebook, Twitter and others could alter venture capital landscape.” This is a claim we have seen from many industry insiders, resurrecting the debate of whether or not the social media feeding frenzy represents another tech bubble.

While Patrick echos many of the same arguments supporting the prevailing sentiment, I don’t believe the bubble controversy will be the driving force that he claims is ready to alter the VC landscape in 2011 or beyond. There are larger, more enduring forces at work.

IPOs used to be the holy grail that tech entrepreneurs strived to achieve with their companies. Now, you see companies like Facebook doing everything they can to avoid going public. Why? Primarily because the federal government has made it much more onerous to be a public company. And, with the public option no longer a viable exit strategy, VCs are examining present valuations more carefully than ever before, and brought more discipline into the market. In addition, there are generational and other issues that are shrinking the “supply” side of the equation, enabling VCs to be even more selective in their decisions.

In contrast to the last tech bubble, the current crop of tech companies like Google, Facebook, and LinkedIn have successful business models strengthened by an enormous user base, unlike their “dot com” predecessors. I think the bigger picture here is that the technology industry continues to reinvent itself with a new set of “next gen” companies every few years — which is why maintaining a focus in tech is critical.

With the inevitable impact on liquidity arising from the evolving supply and demand equilibrium, secondary markets are emerging to fill this void. The ostensible frothiness of this market is helping valuations, as it provides liquidity for shareholders and employees of these hot companies that were traditionally only accomplished through an IPO. But this market reminds me of the “greed factor” prevalent in the first internet bubble, when investors bought shares of companies without looking closely at the data. Greed is a powerful motivator which compels otherwise rational investors to do irrational things; and just like the last bubble, it is these secondary markets that likely won’t survive a downturn.

At the same time, the federal government must acknowledge that the best companies no longer want to go public in the United States, and will do almost anything to avoid it (just look at Google, who eventually went public only because they had too many private shareholders). We need to redesign our IPO process before other countries do it for us.

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