Cooley partners Jon Avina and Jamie Leigh authored an article in Axios about what to expect from the IPO market in 2023 and how a healthy number of transformative technology companies are in the IPO pipeline and are aiming to be IPO-ready by 2024 or 2025.

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The volatility in U.S. capital markets has made it extremely difficult to execute successful IPOs that perform well in the aftermarket.

While the IPO market in 2020 and 2021 saw many successful consummations, the future outlook of deal terms may look different going forward.

However, Cooley partners Jon Avina and Jamie Leigh say a healthy number of transformative technology companies are in the IPO pipeline and are aiming to be IPO-ready by 2024 or 2025.

Here's what you need to know.

1. First things first: What factors can we expect to influence the market for IPOs in 2023?

Avina: We'll need to see a few well-known bellwether companies successfully test the market before the window is considered open for a broader group of smaller companies.

  • With some confidence that inflation is under control and market volatility has decreased, other tech companies will know it's safe to go back in the water.
  • At Cooley, we've talked to a lot of companies that, once the window does open, want to be the "second" IPO to avoid the challenges faced by newly public companies in a down market — because, once in, there's no turning back.

Additionally, we expect to see a steady increase in IPOs over the course of 2023, but nothing like the IPO market we experienced from 2019 to 2021.

  • The next class of tech IPOs will likely follow the classic IPO playbook and also include anchor investors to signal more conviction in the organization's ability to execute as a public company.
  • I doubt we'll see a significant number of direct listings until the market comes roaring back. And if history is a guide, we'll also see more balance between growth and profitability instead of growth at all costs.

2. Looking ahead: Which sectors of the tech space do you think will be the first to test the market once the IPO window opens?

Avina: Enterprise software has always been the industry that leads the way in these situations.

I'm excited about the future because of the great companies we have in many vertical markets that are gaining traction and scaling in the enterprise software space. And I expect they'll have great outcomes over the next few years.

  • However, investors will want to see companies that have sticky products plus the ability to execute against the "beat and raise" expectations of Wall Street — but this is easier said than done when balancing scale with efficiency.
  • Building a talented engineering and sales workforce takes time and money, but these dials have to be carefully calibrated to line up with the Street's expectation of growth and profitability, which can quickly change based on macro factors.

3. The strategy: What will exit opportunities and dealmaking look like for tech companies unable to preserve cash and extend their startup runway?

Leigh: We expect a significant uptick in both private capital financings and sell-side M&A, especially in the second half of 2023.

  • Companies will be grappling with the decision to either raise capital at lower valuations than prior rounds or explore strategic alternatives, like selling the company or accepting more buyer-friendly deal terms.

For private capital financings, the days of growing into the valuation are gone — at least until the next frothy market, which could be in five months or five years given the tech industry.

(But that's part of what makes this industry so exciting.)

  • This can result in price-based anti-dilution adjustments for earlier investors who invested at higher valuations in 2020 or 2021, or, in more extreme situations, a complete recapitalization of the company that requires a lot of creative dealmaking.

We could also see a return of "pay to play" terms as a way to encourage current investors to continue to support the growth of the company.

  • Other investor-friendly terms — such as senior liquidation preferences, valuation hurdles for auto converts or tougher price-based anti-dilution structures — may become more common.

For M&A, buyers will have more leverage to impose tougher terms on sellers, which could mean more buyer-friendly indemnity packages and broader interim covenants and closing conditions.

  • Buyers may preserve more of the deal value for continuing employees, which presents structuring challenges as investors fight for a bigger portion of a shrinking pie.
  • They may also condition the consummation of these transactions on certain employees agreeing to stick around and not compete with the combined company for a period of time.

Despite all of the headwinds to dealmaking, Cooley's clients in the tech space always remain creative and open to deploying strategies with slightly more risk tolerance than the norm.

We anticipate that savvy buyers won't sit out an entire deal cycle on the sidelines.

4. Why it's important: Could current valuation multiples complicate the ability to raise capital for public and private companies in 2023?

Leigh: Certainly.

  • For M&As, this fever will have to break before we see an uptick in deals, as public company buyers face a lot of pressure from having their valuations dramatically impacted by the market downturn.
  • While many buyers raised a significant amount of cash and have public company currency in the form of stock for deal structuring, they're also keeping a close eye on cash burn and dilution.

Ultimately, we'll need to see better alignment between private company valuation expectations compared to public company comparables.

  • This is especially so given the current market multiples, which I don't see changing throughout 2023 with the macroeconomic environment of higher interest rates and investor sentiment around growth versus profitability.

5. Next steps: What strategies does Cooley recommend for tech companies looking to balance growth and profitability and attract potential investors in 2023?

Avina: The right strategy will largely be driven by the long-term outlook for each company.

An example: If you're confident in your growth plan but know it'll require continued investment to succeed, you'll likely want to double down on investing in that growth despite its impact on short-term profitability and the tough environment for raising additional capital to fund this strategy.

Here's why: Public company investors still expect to see compelling growth from tech companies that want to go public.

Some tech companies that raised significant private capital prior to the market downturn in 2021 will have the good fortune of executing their business plan without having to go out into the rain of the public or private markets until 2024.

  • While many of these companies will want to be nimble with respect to an IPO or sale of the company, my advice for companies that can wait out the storm is to focus on execution while continuing to develop relationships with future investors and analysts through non-deal roadshows.
  • Those relationships will bear fruit once the window reopens and the sun comes back in.

At Cooley, we're actively reaching out to companies in the tech space that are asking themselves these questions — we share with them what we see in the market and how to best use this time to position themselves for an IPO in the next few years.

Learn more about Cooley's 2023 business insights.

Originally published in Axios

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