The tech IPO window is open, but not wide open

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For nearly two years there were no big technology IPOs. Then, suddenly, three came along at once. In the past two weeks, the successful offerings of Arm, the chip designer, Instacart, an online grocery delivery service, and Klaviyo, a marketing automation company, have all followed a broadly similar arc. All three priced their shares at or above the top of their guidance ranges, experienced hefty “pops” on their debut, then fell back a little. Together they provide welcome evidence that, after slamming shut following a record-breaking 2021 as inflation and interest rates rose, the “IPO window” for tech and other companies to come to the public markets is open again. But it is not wide open.

All three IPOs had somewhat unusual characteristics. Their owners sold no more than about 10 per cent of the shares — giving them less incentive to max out the initial payout, and more of an interest in ensuring the shares traded well once they floated. For Arm’s owner, SoftBank, for instance, the chip designer will still be its biggest asset. It took few chances, hiring four lead banks and 24 more bookrunners — in effect signing up much of Wall Street as cheerleaders for the deal.

Though Arm’s offer was big in cash terms, at about $5bn, such limited free floats can create a squeeze that boosts the price. The average free float for US IPOs in the past five years has been about 20 per cent; the London Stock Exchange requires a 10 per cent minimum. All three companies also allocated chunks of the shares to “cornerstone” investors. For Arm, these included tech groups such as Apple and Google; in Instacart’s case — unconventionally — Sequoia Capital, the venture capital firm, and several more of its existing private backers were lined up to buy up to three-fifths of the deal.

Despite such efforts, Instacart’s float valued it at barely a quarter of its $39bn peak private valuation two years ago, though Arm and Klaviyo were closer to previous private values. With interest rates showing signs of peaking, that suggests there is renewed market appetite for tech company shares — but within strict limits.

This is no return to 2021, when valuations soared to dizzying levels, and many investors were burnt. Goldman Sachs has found the 2020-21 IPO wave had an “abysmal performance relative to history”, the median offering lagging behind the broad US market by 48 percentage points in the following 12 months. Investors today want profits and positive cash flow, not just future growth promises.

Where does that leave the horde of VC-backed tech and other start-ups, which have been starved of fresh funding during the downturn and waiting for market appetite to return so they could raise money? Some like Instacart with particular needs (the grocery delivery group had to find $500mn to pay tax linked to employee stock compensation) will opt to accept a “down round” IPO, involving a cut on previous private valuations. And where private backers put in much of their cash in earlier funding rounds, they may still be able to sell at a decent premium.

This will at least allow private tech valuations, which have been in something of a hazy netherworld, to be “marked to reality”. VC investors selling existing holdings frees up capital to plough into new ventures. The years of cheap money and plentiful private funding, moreover, heightened the tendency for start-ups to remain in private hands for longer. Moving them on to public markets exposes them to greater scrutiny and allows retail investors to share in the potential value creation.

Public equity markets are the lifeblood of capitalism, and dynamic growth companies should be the lifeblood of public markets. If that cycle is starting up again, with more realism among investors, that is all to the good.