LinkedIn: How Long Will Rich Investors Stay Rich?

One of the lessons that was learned from the internet bubble of 1998 to 2000 is that many tech company founders woke up one day and found that they were billionaires on paper. By the end of 2001, most were out of work and their stock certificates were worthless. The founders of LinkedIn, the professional social network now have about $2.5 billion in stock among themselves after the company went public at $45 a share.

Most experts think this boom will be different from the one a decade ago.The primary reason is that so many investors were burned. The other is that apparently firms like LinkedIn have enough revenue so that they will not burn through the proceeds of their IPOs. That should cause the public to wonder why they need the money which comes from an IPO at all.

The argument for IPOs is that they allow early shareholders to eventually sell their stock for a return on their investments. Additionally, new public investors can become fabulously rich as owners of the newly issued shares. Of course, the original investors have the advantage that the first moneys into these operations receives their ownership at very low prices because these investors took all of the early risk. Whether that means that they should get returns that may be tenfold or better is an open question. These venture capitalists make the point that they supplied the money that made the existence of  LinkedIn possible in the first place.

The trouble with an IPO process that allows early investors to cash out at huge multiples has always been the same. They sell their shares over time, which is not just a means to make a profit, but a core lack of faith in the futures of the companies they have financed. The new stock will not increase by a factor of ten as their first investment has.  Early stock holders and management usually  have a “lock-up” period when they cannot sell shares of an IPO, but these usually do not last longer than 120 days.

The tension between early investors and those who buy shares in an IPO exists because no original money believes that the future will be as good as the past. Caveat emptor, they may say, but better to exclaim that there is a sucker born every minute.

Douglas A. McIntyre