IPOs Let Companies Raise Capital: Myth?

"Tweet, tweet. I need capital!"

Over at Slate, Matthew Ygelsias calls out four interesting points from Twitter's S1 filing, and all of them are good ones. His fourth point, though, did make me pause: "IPO's aren't about raising capital."

In a sense, he's absolutely right. Almost all tech IPOs--and Twitter is certainly no exception--are not undertaken because the companies need to raise capital to fund the business. Indeed, they are exit vehicles for the original investors--generally venture capitalists--to get their money out of the business (along with, in most cases, a handsome profit.)

IPOs like Twitter, Yglesias argues, puts the lie to the old myth that the purpose of the stock market is to let firms raise capital. But, I don't quite buy that. The stock market is doing exactly that for tech firms, only in an indirect way.

No one could create a start up in his or her garage, hire a few people and make a splashy demo, and then file an S1 and go public. No one would buy the stock. Instead, early investors are willing to take a risk and invest multiple millions of dollars in the company because there stock market is out there as one potential "exit strategy" so they can have a "liquidity event", as the jargon goes.

An IPO is not the only way for investors to cash in--they could always sell to another larger company, for instance, which frequently happens. But, without the prospect of a potential IPO out in the future, it would be far, far harder for tech entrepreneurs to raise the money they needed to get their big idea off the ground. So, to my mind, at least, it seem the stock market is doing exactly what it has long been rumored to do: letting firms raise capital.