Etsy sent out an email to all sellers on Wednesday stating that the company is going public. The Etsy Initial Public Offering (IPO) could take place as early as April, but we won’t know in advance the exact date or share price.
I thought I’d take a look at what an IPO really is, how it works, and what might be motivating Etsy to go public. I’m always interested in the “why” behind these things.
An IPO is an indicator that a company is ready to grow and needs a lot of money to do so. It’s often the only way that a company can fund a huge expansion. Etsy is hoping to raise $100 million in the IPO.
Let’s look at how Etsy has been funded up until now. Since its founding in 2005 Etsy has been a private company. Private companies have just a few shareholders. Right now Etsy has 312. These shareholders help fund Etsy’s operations and in exchange have voting rights. The main shareholders now are four venture capital firms:
- Accel Partners controls 27% of Etsy
- Index Ventures controls 12.8%
- Tiger Global Management controls 7.3%
- Union Square Ventures controls 15.2%
Venture capital firms and individuals invest in a private company like Etsy because they are hoping that the company will grow, go public, and eventually they’ll be able to sell their shares and make a large profit. They offer their guidance and expertise along the way.
Now, Etsy is ready to expand. To do so they need to raise money. One way to do that is to borrow it. Another is to bring on more investors. A third way is to go public.
When you go public you sell off tiny shares of the company to the general public. In order for shareholders to have a say in the company’s management they would need to buy as many or more shares than the company’s management and largest investors. This typically means owning at least 5%-10% of the company’s stock. So people don’t tend to invest in public companies solely or primarily to influence their management or change their way of doing business. People buy shares in a public company for the same reasons investors invest in any company – they believe that the company will become more profitable at some point in the future at which point they could sell their shares and make money.
A few months after the IPO the venture capitalists will be able to sell their shares to the public and realize (meaning make money from) their original investment in Etsy. In all likelihood they will make an enormous profit on these sales.
Once a company goes public they are held to strict rules and regulations. They have to have a board of directors, for example, and they have to submit detailed quarterly financial reporting to the public. They also have to have their financial results and operational procedures audited and certified by a major public accounting firm. These audited financial statements are in turn made public and have a lot of detailed information about the company, but can be challenging to understand if you don’t have an accounting background.
Once the company is public they’ll be better able to raise capital for future growth and to repay debt by issuing more stock.
It’s also easier for public companies to buy other companies, public or private, because they can offer stock as part of the deal. Etsy has bought four companies over the past few years:
- in 2012 they bought Trunkt for $200,000
- in 2013 they bought Lascaux (an iOS app) for $750,000
- in 2014 they bought Jarvis Labs for $3.2 million
- also in 2014 they bought Incubart (which owned the French online marketplace A Little Market) for $30.8 million
If Etsy wants to buy more companies in the future it will be easier to pull together a deal because they’ll be able to use their publicly traded stock as currency to exchange for control of the companies.
The increased reporting and financial scrutiny that is required of a public company can also allow them to get better interest rates if they need to borrow money in the future.
A final advantage of going public is the ability to attract top talent to work for you. Being public means you can offer stock ownership to your employees through stock options that they can sell in the public markets. Right now Etsy’s employees own private stock and options to acquire private stock, but have very limited ability to turn it into cash.
Taking a company public is a long and involved process.
The company works with several investment banks who help assess the value of the company and handle the sale of the first stock offered. In Etsy’s case they’re working with Goldman Sachs, Morgan Stanley, and Allen & Company. Once the shares sell the banks keep a portion of the proceeds as their fee.
The banks look over the financials and help Etsy put together a prospectus that they file with the Securities and Exchange Commission (SEC). Etsy filed their initial prospectus on Wednesday. In the prospectus Etsy explains it’s strengths and weaknesses. They also file a registration statement indicating their plans to go public. As the IPO gets closer, these filings will be updated and additional details disclosed as they are finalized or at the direction of the SEC.
Now it’s the banks’ job to find some big investors. The banks go on what’s called a “road show” traveling all over the country talking with potential investors and trying to convince them that they should invest in Etsy. These investors are typically institutional investors such as mutual fund managers and hedge funds. Occasionally very wealthy private investors are invited to the presentations as well. During the road show Etsy goes into a “quiet period” in which they can’t comment on anything related to the IPO just in case they say something that affects the stock price. If they break this rule there can be enormous fines and criminal penalties.
There are significant legal fees, accounting fees, and marketing costs involved in going public that often add up to millions of dollars. It’s also incredibly time-consuming for the top management, taking about a year to complete in total.
Public companies have to disclose detailed information that competitors might use to their advantage. For example, we now know that “seller services” (promoted listings, direct checkout, and shipping labels) is Etsy’s fastest growing revenue source, growing from $43 million in 2013 to $83 million in 2014.
How will being a public company affect Etsy’s behavior? I think this is the key question for those of us who sell on Etsy now. Reading the Etsy forums and looking at responses to the announcement on Facebook people are really worried that shareholders won’t care about values, they’ll only care about profits which means Etsy will be overtaken by resellers, or that we’ll start seeing pop-up ads or other aggressive marketing tactics used to try to increase profitability
While it’s impossible to predict how Etsy might change once it’s public, there’s no reason to think that the business model will shift fundamentally. In fact Etsy’s shareholders will be eager to see them sustain their current business and business model which has been so successful. If they want to buy shares in a company that is a platform for resellers they can buy shares in Alibaba.
But that said, going public makes a company’s management focus on the share price and on their quarterly financial reports to the shareholders and the public in a way that a private company doesn’t. This can be distracting and in some circumstances leads companies to make huge mistakes and bad decisions.
There’s no way to know exactly how Etsy will look a year after the IPO, or three years out, but at least we can get a better understanding of what’s going to happen over the next few months. Etsy has always had investors. Soon it will have exponentially more.