What Is a Venture Capital-Backed IPO?

The term venture capital-backed IPO refers to the initial public offering of a company that was previously financed by private investors. These offerings are considered a strategic plan by venture capitalists to recover their investments in the company. Investors normally wait for an opportune time to issue this type of initial public offering in order to maximize their return on investment (ROI).

Key Takeaways

  • A. venture capital-backed IPO refers is the initial public offering of a company previously financed by private investors.
  • Venture capitalists use VC-backed IPOs to recover their investments in a company.
  • Investors wait for the most optimal time to conduct an IPO to make sure they earn the best possible return.
  • Low investor confidence during lean economic times can limit the amount of VC-backed IPOs on the market.

Understanding Venture Capital-Backed IPOs

Venture capital is a type of private equity. This kind of financing is provided by investors and firms to companies with high growth potential or to those that demonstrate high growth. Venture capital firms or funds invest in early-stage companies in exchange for an equity stake, taking on any of the associated risks in the hopes that some of the startups they support will become successful.

The typical venture capital investment occurs after an initial round of seed funding. The first round of institutional venture capital to fund growth is called the Series A round. Venture capitalists provide seed capital so they can maximize their return through an exit strategy such as a venture capital-backed IPO. And because they provide new companies with a great deal of their initial financing, they have certain rights and responsibilities, including how and when a company goes public.

Venture capitalists look and wait for the most optimal time to conduct an IPO. This is to make sure they're able to exit their position in a company while making the best possible return. The alternative to an IPO for a venture capital-backed company is being acquired—getting purchased by another company. The acquisition of a venture capital-backed company is known as a trade sale. Both options are known as exit strategies because they allow venture capitalists and entrepreneurs to get money out of their investments.

The alternative to a venture capital-backed IPO is an acquisition.

Multiple sources regularly report on both venture-capital-backed IPOs along with the volume of mergers and acquisitions (M&A). In lean economic times, there tend to be fewer venture-capital-backed IPOs because of low investor confidence. As a result of the financial crisis, 2008 and 2009 saw record low numbers of venture-capital-backed IPOs.

Special Considerations

Venture capital, just like angel investing and crowdfunding options, is an attractive option for new companies. This is especially true for entities that have limited operating histories and are too small to raise capital in the public markets. Companies that fall into this category may not be at the point where they can secure a bank loan or complete a debt offering.

Attracting venture capital is very different from raising debt or a loan. While lenders have a legal right to interest on a loan and repayment of the capital irrespective of the success or failure of a business, venture capital invested in exchange for an equity stake in the business carries no such legal protection and is speculative in nature. The return on a venture capitalist's investment depends entirely on the growth and profitability of the business. This means that a venture capitalist takes a risk of loss along with the expectation of a return on their investment.

Example of Venture Capital-Backed IPO

Tesla and Open Table both went public in venture capital-based IPOs. Another great example of a venture capital-backed IPO is Uber (UBER). The ridesharing company was founded in 2009, raising nearly $20 billion from venture capitalists including Morgan Stanley, SoftBank, and G Squared. The company's final round of financing took place in 2018 when it raised $500 million. Uber went public in a venture capital-backed IPO in May 2019. Shares were priced at $45 each, allowing the company to raise roughly $8 billion.