Profitable vs Non Profitable technology IPOs

March 29, 2010

IPOs are the ultimate prizes for technology company founders and their venture capital advisors. As the technology IPO market is regaining some of its health (with the Wall Street Journal profiling the 100-million club of likely candidates for IPOs), we should be seeing some spectacular IPOs in the future.

However, not all IPOs are born the same. The following chart, taken from Wall Street Journal and the Tableau Data Visualization software website, tells of a very interesting story.

To quote the analysis done
Perhaps unexpectedly, in the first two years after the IPO, the average returns of the unprofitable group easily outperformed the profitable companies. After year one, average returns were 86% versus 39%, respectively. By the end of year two, those figures grew to 110% versus 89%.

But everything changes by the third year. While the average returns of the profitable group continue to climb to 153%, the unprofitable group’s returns fall off a cliff to 36%. That’s a significant difference.In short, companies that IPO when they are profitable appear to be less “sexy” than their unprofitable counterparts, perhaps because they were not as aggressive in growing the top line at the expense of the bottom line and that’s why the public markets punish them for the first two years.

However, by the third year, perhaps the growth prospects of the unprofitable group are unrealized, and their inefficient use of capital start to hurt their returns. I am quite sure that had the data extended further more, the “profitable IPO” companies will get better even better returns overtime.

This is actually very consistent with the investment philosophy at OpenView Venture Partners. Being value add investors who seek to provide a lot of operational support for our portfolio companies, we are extremely particular about the profitability of its economic model. Expansion capital can be really wasted if put in a company that does not have sound sales and marketing economics, as the company will simply spend that capital away and go back for more money. As this chart also shows, even if the company somehow manages to raise enough to grow and exit, it will not be a very successful company in the long run, unless it fixes its economic inefficiency. Therefore, we focus on providing a lot of hands on sales and marketing support to help our portfolio companies perfect their control of profitability, before they execute their exit strategy.

Chief Business Officer at UserTesting

Tien Anh joined UserTesting in 2015 after extensive financial and strategic experiences at OpenView, where he was an investor and advisor to a global portfolio of fast-growing enterprise SaaS companies. Until 2021, he led the Finance, IT, and Business Intelligence team as CFO of UserTesting. He currently leads initiatives for long term growth investments as Chief Business Officer at UserTesting.