There are three main ways for startups that raise money to return it to their investors. First, they can stay independent and just exist as private, hopefully profitable companies. Second, they can sell to an acquirer and be part of a larger organization. Or third, they can go public and exist at the whim (but with the liquidity) of public markets.

For along time, startups used the third option most, but more recently—and especially in the consumer goods space—going public has ceased to be the norm.

Instead, companies are staying private for much longer. This is driven by a number of factors:

  • As new markets open up thanks to increasing globalization, companies want to get big as quickly as possible in order to lock in scale advantages. Thinking long term is the only way to make these investments and accomplish this, and public markets are known to shy away from such long-term growth at the expense of short-term earnings.

  • Given record low interest rates on bonds, money has flowed into equity financing, giving private market investors more gunpowder to invest in companies, thus allowing them to continue getting funding from non-public sources. This shift has even forced public market funds, such as giants like Fidelity and T. Rowe Price, to allocate an increasing amount of money into private investments. Uber, Airbnb, Pinterest and Lyft have stayed private for much longer, which would not have been the case if they were founded in a previous era.

  • Given all of the focus on growth at all costs, this has further eroded the ease at which private companies can transition to the private market; many are not profitable and won’t be anytime soon—a position that is much harder to keep under the scrutiny of public market investors.

Staying private

Venture capitalism is like—Wall Street, without liquidity; whereas on Wall Street, an investor can sell stock at any time, startup investments can’t be sold. This means that private market investors, founders and employees are somewhat trapped, beholden to and often restricted by illiquidity.

Take the Honest Company, the household and baby brand founded by Jessica Alba in 2011. Because of Alba’s celebrity status, VCs flocked to the company, which, inundated with so much money, was forced to grow unsustainably. In less than five years, Honest Company had produced 100 SKUs; in six, it had raised $303 million. Though the company sought either an IPO or an acquisition, both fell through—in the end, Honest Company was too expensive for Unilever, which decided to buy competitor Seventh Generation for $600 million instead. Because the company wasn’t profitable, it relied on financing to stay afloat, which further exasperated the problem of overvaluation, making an acquisition less likely. After the deal with Unilever fell through, Honest Company’s valuation fell from $1.7 billion to $1 billion, and its new CEO has strived to focus energy on Honest Company’s faster-growing wholesale channels.

The digitally-native razor brand Harry’s is earlier along in its life cycle, but since its founding in 2011, it has raised $474.6 million in venture capital—more than any digitally-native company. Soon after its latest round of financing—a Series D fundraise of $112 million—Harry’s announced it would become a platform and holding company for other digitally-native brands outside of the shaving sector. Though investing in and acquiring other brands may have been a long-term goal for Harry’s, the newest fundraise accelerated the initiative. Now Harry’s is so overvaluation that it’s hard to imagine a future acquisition or an IPO at all.

Going public

On the other hand, public market investors expect companies to grow reasonably, with a focus on both the short and long term. Paradoxically, Wall Street honors short-term, quarter-to-quarter thinking that prioritizes sustainable metrics like profitability rather than just top-line growth. If VCs want to see profitability in three to seven years, public investors want to see it much sooner, which is a more difficult way for companies to grow. But the trade off is that investors, employees and founders can sell their investment at anytime, which is the price of liquidity.

When Snapchat went public in March 2017, it did so at a time when its main competitor Instagram had approximately 200 million daily active users on Instagram Stories. Snapchat wanted to IPO in order to invest and defend itself in this landscape. But the following quarter, it saw a $2.2 billion loss and acquired only 8 million new daily active users. As a public company that had to report these findings, Snapchat had a difficult time keeping its stock price up—with the news, it plunged 25%. In turn, employee morale fell, as so much of their compensation is tied to the company’s stock price.

Long-term trajectories

Long-term growth, however, is possible in the public markets. Amazon is a good example of a public company acting as a private company. In doing so, it has successfully trained investors away from the status quo, persuading them to invest in long-term growth. The company’s profits are relatively small compared to its sales ($1.6 billion and $51 billion in Q1 2018, respectively)—a disparity more characteristic of a private company, where VCs vie for more growth now and assume profitability is the job of whomever acquires the company down the road. But Amazon’s entire spiel is that the company will be highly profitable in the future, once it has reached such massive scale that no one can challenge it.

Though Amazon has unique advantages because of its scale, the takeaway is that companies need to maximize optionality no matter whom they’re taking money from or what size they are. Founders who balance what they want now with what they’ll want later will be more predisposed to forge a path that gets their company there. Staying smaller gives a company more flexibility, whereas those that fall victim to fundraising hysteria and become overvalued can restrict their options moving forward.