Under Construction: Why and How to Build a Pre-IPO Board

This is an abbreviated version of a more thorough article exclusively for NACD members. If you are an officer or director of a public, private, or nonprofit organization, you can become an NACD member to view the complete article and related resources.

Picture this: Tech stocks soar in valuation over the course of a few years as excitement builds around new digital capabilities, even if the tech companies that are going public aren’t always profitable. Then these companies begin to go under and disappear, and the economy turns bearish. Sound familiar? This describes the dotcom crash of the early 2000s. Though what has happened in the markets over the past couple of years and during the COVID-19 pandemic is similar, 2020’s bear market lasted a record-short 33 days—and initial public offerings (IPOs) are back in full swing, with tech and health-care companies that have benefited from the prolonged crisis leading the surge.

But the number of IPOs has largely declined since 2000. In the mid-1990s, more than 8,000 companies were traded on US stock exchanges. In 2015, there were only half that number. And while 1996 saw 677 IPOs—as classified by Jay R. Ritter of the University of Florida’s Warrington College of Business, and excluding special purpose acquisition companies (SPACs)—there were just 165 last year.

The National Securities Markets Improvement Act of 1996 effectively deregulated private markets by limiting the purview of state blue sky laws, making it easier for private firms to obtain investment. The 2012 Jumpstart Our Business Startups Act increased the number of investors permitted at big private firms from 500 to 2,000. These laws generated incentives for companies to stay private, but other speculative reasons for the IPO decline abound. Nowadays, private companies in general have greater access to private capital, may want to avoid the burden of public company disclosure and compliance requirements, and may possess an overall distaste for the high cost of going public (paying lawyers, auditors, exchange fees, etc.).

Despite the pandemic and the decline in the number of public companies over the past two decades, according to Ritter’s scale, 2020 had the highest number of IPOs in the United States since 2014. By other estimates, the first quarter of this year saw the number of IPO filings increase by more than 700 percent compared to the same period last year, in part due to the increase in the popularity of SPACs or blank-check companies. The United States has seen a long-running bull market from 2009 to 2020, as well as low interest rates, strong trading and high liquidity, and virtual road shows that shorten the IPO process and increase access to investors. Changes in consumer behavior due to COVID-19 restrictions gave some companies a push toward the IPO market, as well, such as Roblox Corp., an online gaming business, and DoorDash, a food-delivery company.

As the IPO market crests this new inflection point—seen by some in the industry including Ritter (who has been nicknamed “Mr. IPO” because of his research in this area) as another bubble—companies looking to go public must lean on the oversight and abilities of corporate boards. While some pre-IPO companies already have a board in place, not all of them do. Even in instances where a board does exist, listing requirements dictate that the board and business be set up and operate in certain ways. No matter the scenario, it is unlikely that the board of a pre-IPO company will not see some change in its composition or policies at the time the company goes public.

“Building a board to do an IPO is a lot like starting a building from the ground up,” said Lauren E. Smith, managing director at Diversified Search Group and a core member of the firm’s board practice. “Just like when an architect sits down with a new client to learn about the purpose and requirements for a building, [at Diversified Search] we sit down with our client to learn about the company’s business model and strategy so that we can create a blueprint for the best possible board that is fit for the purpose of the company.”

Build-A-Board

Beyond Meat’s IPO is a storied one. Helmed by founder Ethan Brown, it went public in May 2019, becoming the first “meatless meat” company to do so and landing among the most successful IPOs of all time, with a total valuation of about $1.5 billion at the time of the offering and IPO pricing at $25 per share. (As of May 25, 2021, it was trading at about $120.) According to Dealogic, out of all US companies raising more than $200 million in their IPOs, at the time Beyond Meat saw the biggest pop since 2000, with a first-day gain of 163 percent. Honest Tea cofounder Seth Goldman joined Beyond Meat’s nascent board in 2013. The company was only four years old at the time and one year into selling its retail products in the US market. Honest Tea had sold entirely to The Coca-Cola Co. in 2011, and Goldman was ready to use his entrepreneurial knowledge in new ways.

In a conversation with Directorship, Goldman reflected on his experience building a board at Honest Tea and the importance of doing so at any company, regardless of whether it intends to go public.

“We created the board just after we had raised over a million dollars,” Goldman said. “The first reason was that we should have someone there to represent shareholder interests, but the other thought was that this was now a serious undertaking. Not that I didn’t think about it seriously before, but now we were tapping into other people’s ideas and other people’s networks, not to mention their money.”

That Honest Tea did not go public should not undermine the importance of having a board. “You are constructing a board for a future that you cannot predict,” said Heather B. Redman, managing partner at venture capital firm Flying Fish Management.

Redman had firsthand experience as senior vice president and general counsel at PhotoDisc in 1998 when it merged with Getty Images. Before the merger, PhotoDisc had been preparing to go public. According to Redman, the moment a company begins doing so, it becomes an entity that people are interested in acquiring, because acquiring a privately held company is both easier and less expensive than acquiring a public company—and there’s plenty of money to be made in taking a company public post-merger or incorporating a private company into a public company. That’s what happened at PhotoDisc.

“If PhotoDisc fully built out a board that was going to be its public company board for the 10 years post-IPO, that might not have been the best thing to achieve the right outcome for the founders and the venture capitalists, which was instead getting a merger deal done,” Redman said.

Her point? Get your all-star board lined up a number of years in advance of an expected IPO. It need not be completely in place, but certainly potential directors should be identified. And build a board that will help you move forward, not necessarily for a specific purpose. If you build a board with only an IPO in mind, your company might miss out on a strong opportunity to merge, for example.

To read the full story, see the May/June 2021 issue of Directorship magazine, now live.