Stacks on stacks

How can Uber raise so much money without going public?

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Yesterday, Uber announced that its latest round of venture capital financing will total $2.8 billion dollars. These kinds of enormous funding rounds seem to be happening almost weekly—just this week, we’ve had Snapchat raising $500 million at a $19 billion valuation, and Pinterest also raising $500 million at an $11 billion valuation—and they raise a big question: do these companies ever have to go public? Or could they raise money in the private markets forever?

First, a little basic background: in the first dot-com era, there was a predictable life cycle for hot tech companies. First step, have an idea—say, Then, hype the website, get some users, maybe generate some revenue (this step was very optional), and then hold an initial public offering, taking the company public so that its stock could be bought and sold by average investors. After the IPO, insiders often sold some or all of their shares, and the founders often got fabulously wealthy. Meanwhile, the poor schmucks who bought shares on the public exchanges often got left holding the bag when the companies went bust.

One reason these companies loved IPOs is simple: they allowed insiders to turn hypothetical money into real money without requiring profits. But the other reason that IPOs were so popular was that the law encouraged it. In the aftermath of the stock-market crash that touched off the Great Depression, Congress passed the Securities Exchange Act of 1934, which included a provision that companies above a certain size and “whose securities are held by more than 500 owners must file annual and other periodic reports.” In other words, if you had 20 or 200 or 400 shareholders, your financial secrets—profits, revenue, executive compensation, things like that—could stay private. But the moment you got your 501st shareholder, you were forced to release this information publicly, whether your stock was publicly traded or not. You also had to register your equity securities with the SEC—and, as Felix Salmon explained back in 2011, that meant that “your shares can be traded by anybody at all in the public over-the-counter markets, even if you haven’t had an IPO.”

So for companies approaching the 500-shareholder mark, the choice often became obvious. Your competitors are going to see your company’s innards anyway, and the public will be able to buy your stock if it wants to—so why not have a proper IPO?

The 500-shareholder rule was grounded in the idealistic principle that larger companies should provide investors with greater transparency so that they couldn’t snooker the public. But in 1999, the flood of ill-advised IPOs, fueled by insider greed as well as (and perhaps moreso than) regulatory pressure, ended up creating billions of dollars in losses for average investors when those companies ultimately failed.

These days, lots of successful tech CEOs hate the idea of going public. It’s expensive and time-consuming, it requires disclosing sensitive information, and it gives fickle Wall Street investors a say in your business. In the years after the dot-com boom, some tech companies tried to find ways around the 500-shareholder rule in order to stay private for longer. (Most memorably, Facebook tried to work with Goldman Sachs on a deal that would use a legal technicality to let its high-net-worth clients buy Facebook shares while keeping the official number of investors below 500. The plan, which Businessweek termed an “initial private offering,” blew up in spectacular fashion, and Facebook went public shortly thereafter.)

If Uber had existed in 1999, the 500-shareholder rule may have forced it to go public by now. It likely has more than 500 shareholders, once you count its executives, its myriad venture capital backers, and other investors it’s picked up in its fundraising spree.

But several years ago—perhaps thanks in part to the negotiations around Facebook’s ill-fated Goldman deal—the rules changed.

The 2012 JOBS Act raised the shareholder cap to 2,000, as long as there are no more than 499 accredited investors among that pool. (So you can have 1,501 employees with stock, and 499 venture capital investors, and still not have to disclose your financials.) Cooley LLP, a law firm that counts Facebook, Tesla, and Google among its clients, noted that the law would allow more companies to stay private for longer.

There are three other reasons, though, that we’re seeing ever-larger sums flowing to start-ups in the private market.

For one, the latest round of startups that interact with the physical world (Uber, Airbnb, et al.) need more money than software-only companies. Google only raised $25 million before going public in 2004. They wouldn’t have known what to do with $2.8 billion. But a company like Uber can’t just scale its servers on the Internet. It needs to scale in actual, physical places, using real people and on-the-ground effort. And that costs money. They’re also using some of this money to fight regulatory battles, and subsidize their services in hopes of crushing the competition.

The second, simpler reason that Uber keeps raising money in the private markets is because it can. Before a few years ago, it simply wasn’t possible to raise billions of dollars as a private tech company—that kind of money didn’t exist in the tech venture capital world, no matter how successful your start-up was. (For context, to invest $1.2 billion in Uber today, Kleiner Perkins, one of the biggest venture capital firms in Silicon Valley, would have to hand over its entire most recent fund.)

But now, Uber’s popularity and explosive growth has gotten it access to a range of non-traditional tech investors, like hedge funds, giant mutual funds like Fidelity, the Chinese Internet conglomerate Baidu, and even Qatar’s sovereign wealth fund. These institutional investors have a lot more money than Silicon Valley venture capitalists. And they’re showing up to Uber’s door with what the Times calls “overwhelming demand” for the company’s stock.

And finally, the pressure from a company’s employees for an IPO payday has been alleviated by the growth of secondary markets like Sharepost, which allow employees and investors to sell some of their shares or options. (Although selling stock on the secondary market is still far harder than selling it on a public exchange.)

Still, Uber’s employees and investors are probably hoping for an IPO at some point in the not-so-distant future, since it would give them an easy way to cash out part or all of their stakes. But, insider paydays aside, there’s no real reason Uber has to go public, unless its financial needs grow too big for even its current investors’ pockets. And you can understand why CEO Travis Kalanick would want to grow in the private markets instead of cashing out When you’ve got a good thing going, why give it away to the masses?