3 Reasons VCs Can Get IPOs Very Wrong: Glenn Solomon Post

Glenn Solomon, a partner with GGV Capital, contributed a post to Fortune's From the Crowd Blog "3 Reasons VCs Can Get IPOs Very Wrong" which explores some reasons why venture capitalists may over-value private companies prior to their initial public offerings.  The post was written on May 21, just after Facebook's IPO (which looked successful at that time), but before Facebook's stock price broke the IPO price.  The post uses Zynga and Groupon as examples of returns VCs have obtained in later rounds or in secondary purchases prior to the IPOs of these companies.  Solomon points to three primary factors that might have played a role in VCs obtaining less than stellar returns from these pre-IPO transactions:

• Growth Rate Emphasis.  VCs are very focused on growth rates and will pay high valuations for companies that are growing very rapidly.  However, the public market isn't willing to pay extra for high growth, so there's a disconnect which may lead to VCs overvaluing a company prior to its IPO.
• Profit Margin Factors.  Many private, rapidly growing companies aren't profitable, and so the basic public market metric of P/E ratio doesn't apply.  Because of this, VCs look at Price/Sales ratios.  While public investors do this as well, they want to see earnings and margin expansion over time.  As it can take time for this to happen, public investors may value these companies lower than VCs.
• Valuing Unproven Models.  When a company introduces a new business model, it won't have comparable companies to use to measure performance.  As a result, public investors can be uncertain as to how to value these companies until the business models are more mature, leading to volatility in valuation.

I think this is an insightful post and a good read.  Here's the link:  
http://finance.fortune.cnn.com/2012/05/21/3-reasons-vcs-can-get-ipos-very-wrong/ 

Link to Glenn Solomon's blog:  
http://sandhillrdmeetswallst.com/