It’s time to bring back the real IPO: Initial profitable offering

No startup should have to depend on a “pop” to succeed.

No company should aim to become an investment unicorn, where profitability is a mythical creature that people talk about but never see.

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A “build it and they will come” mindset is not a viable long-term strategy.

If there’s a “Back to the Future” movie about speculative valuations, we are watching it right now.

It’s a good thing many entrepreneurs today are too young to remember the first time this happened. If they did, they might be more concerned about fundamentals, and less willing to let investors position their initial public offerings (IPOs) for short-term gains.

Startups that IPO the old-fashioned way, as an initial profitable offering, will see their shares outstanding sustain what already works, rather than become gambling chips.

It’s time to honor IPO tradition, or face the consequences.

History rhymes

In today’s age of exuberance, startups are no longer aspiring towards the best use case of an IPO. Rather, they’re using top-line revenue to fuel enthusiasm. They undervalue their initial offering in anticipation of a pop, and hope the resultant halo effect carries their companies forward.

Like famous rock stars and A-list athletes, IPOs that succeed with this strategy inspire thousands of wannabes, despite the fact that success is nearly impossible to replicate. Yes, there are always exceptions, those companies that pop and then continue to climb higher. LinkedIn did it, but LinkedIn has a way to make money. Facebook never popped in the first place, but managed to climb up anyway. Climbing after a failed pop is unicorn behavior. It almost never happens. Facebook climbed because it happens to be the biggest social networking company in the world. These cases don’t represent the norm.

Without fundamentals in place, most startups are destined to become more like Groupon or Zynga, arduously sustaining, or hovering above record lows. Once the exuberance disappears, you want to be able to survive on more than hope and hearsay — and that’s when the strategy falls apart.

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The other kind of retro IPO

Compare the classical pre-IPO metrics with the ones applied today. In the past, a company would have to at least break even in terms of cash flow (by way of EBITDA) before going public. If it could go further and show one or two quarters of profitability, the chances of a blockbuster IPO increased. Such companies — Google, with its $85 IPO that has since increased 1,294 percent, is an example — were able sustain their IPO share prices and then go higher. That momentum carried their company’s valuation, stock price, market confidence, and ability to attract talent.

Today’s companies are betting on that kind of result without doing the prior legwork to get there. Investing millions of dollars for sales and marketing to grow your verticals, timing the market well, and assuring investors that you’re in it for the long haul isn’t the same as proving a real business model. All it proves is that you’re willing to spend a lot of money selling yourself—to prospective users and investors.

Life after the pop

Let’s say your IPO pop succeeds, and you even gain momentum in the first few weeks afterwards without the fundamentals in place. The true test comes in the following months after the opening bell rings on your company, namely when the investor and employee lock-up period expires. Unfortunately for recently IPO’d Hortonworks, it has seen some tough times since making its IPO debut, with a path to profitability still well out of reach. While it has showcased projections for 70% year over year growth in revenue during its most recent earnings call, it also reported a net loss of $90.6 million, or $5.38 per share.

Enough cannot be said for what solid fundamentals and a clearer path to profitability would have done for investor confidence, especially in a time where investors have become extremely savvy and willing to quickly jump ship to a new investment. Good fundamentals stabilize a company against the vagaries of the market. If your investors decide to dump shares, but the public knows that you’re profitable (or on the way to profitability) and stable, falling stock will be a bump in the road, rather than a source of organizational panic.

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Vineet Jain is a cofounder and the chief executive of file-sharing software company Egnyte.