There’s joy among investment bankers and high-tech investors amid growing reports that many of the largest social media players are considering IPOs. There is heavy speculation that LinkedIn will go public, and that Facebook will be follow suit in 2012. Who knows, maybe Zynga, GroupOn and Twitter will also embrace IPOs.
While this is obviously good news for investors looking for a piece of the action and VCs and entrepreneurs looking to cash out, it is important to remember there is a downside to a flurry of social IPOs.
When a fast-growing company is private, the only number that really matters is user/subscriber growth. This shows investors and potential users a company is showing traction, which suggests revenue and profits are not far behind. This is why there’s so much excitement about Twitter, which has 175 million users but is likely highly unprofitable because it doesn’t have a business model yet.
The problem with doing an IPO is user/subscriber growth becomes just part of the overall mix. Once investors have a piece of the action, revenue, cash flow and profits also become important. At the same time, expectations for growth also increase – and we’re talking about revenue and profits as opposed to buzz and coolness.
Faced with demands from Wall St., many companies have no choice but to change how they do business. When the bottom line becomes important, controlling costs starts to count. This means some of the frills and perks that go along with being a cool, fast-growing company are no longer acceptable to investors looking for improved numbers.
And while subscriber/user growth is still a key metric, revenue and profits matter just as much. There could be, for example, pressure to introduce more premium services while shaving away at free services. Maybe some of the ad dollars being thrown around get pulled back to control spending.
For companies that fail to meet expectations, they’ll get punished by hostile investors looking for scapegoats. Heck, Facebook’s value could plummet by billions of dollars if it missed earnings expectations by a cent or two.
Nevertheless, there will be a bunch of social IPOs because demand is robust. Some companies could thrive in the spotlight while others could wilt under the scrutiny of demanding investors.
The biggest lesson for investors is caveat emptor (aka buyer beware) – something they should have learned during the dot-com bust but will likely conveniently forget amid the excitement of a hot social IPO.
