How Costly is Follow-on Financing After Premature Going-public Decisions?

Abstract

Entrepreneurs often regard Initial Public Offerings (IPOs) as the crowning pinnacle at the end of a highly successful entrepreneurial journey, and studies in entrepreneurial finance therefore rarely extend beyond the going-public decision. This research gap is important because many post-IPO entrepreneurs need to revert to their pre-IPO entrepreneurial investors for follow-on financing in private transactions as they fail to raise additional equity in public markets. While the investment relationship is usually mutually beneficial pre-IPO, the rent sharing in post-IPO transactions is less obvious. Evidence from Private Investments in Public Equity (PIPEs) over the 2001-2018 period in recent-IPO firms suggests highly asymmetric rent sharing. Entrepreneurs earn a negative return of up to -15% in the first post-PIPE year, while investors benefit due to the ability to dictate transaction terms. We find some evidence that corporate governance and asymmetric information considerations matter in the cross section of the returns. The results have real implications for entrepreneurs who often remain CEO of the public company and have a large portion of their personal wealth tied to their company stock.