CHAPTER 14

Unity, San Francisco, April 2019

By the time of Slack’s listing, Bill Gurley was a wise man of Silicon Valley: a Benchmark partner since 1999 and an investor behind such well-known consumer-facing names as restaurant reservation app OpenTable, real estate website Zillow, and Uber. His investments earned him repeat mention on the Forbes Midas List of top VCs.

By June 2019, Gurley had lost his faith in the traditional IPO process. The venture capitalist had worked in Silicon Valley for more than twenty-five years and had seen or participated in dozens of offerings. He was getting prepared to step back from his day-to-day role at Benchmark, giving him more freedom to speak his mind about the inherent conflicts of interest.

His wariness had set in years earlier, when he was still working on Wall Street. “It started a long time ago,” he said later. “I worked on Wall Street from ninety-three to ninety-seven, and the notion that you should match supply and demand and get at a fair price… I’m not the first person who came up with that.”

But his immediate frustration had been growing for at least eighteen months. In November 2017, he was on the board of Stitch Fix, the personalized fashion app, when Goldman Sachs and JPMorgan underwrote the company’s IPO. During the run-up to that deal, he had a conversation with one of the company’s lead bankers that dramatically changed his perception of the traditional IPO process. In a later interview, the venture capitalist shared the anecdote. The banker had called Gurley on the phone. “Bill, this deal is only three times oversubscribed,” the banker had said.

Gurley thought that sounded just fine. Any number over one meant there would be a buyer for every share. “Great,” the venture capitalist said. “Let’s stop the process, print the tape, and move on.”

“No,” the banker said. “That’s the problem. We usually have ten times more supply and demand. We want to get to thirty times.”

Stitch Fix had a lot of retail customers who might want to buy the stock. Gurley asked the banker how much of the deal they planned to allocate to those retail investors.

“Five percent,” the banker said.

How about 20 percent? Gurley suggested.

The banker declined.

The answer suggested to Gurley that the banker had no interest in considering other ways to stimulate demand for an IPO. “Telling us we have a supply-demand problem,” Gurley said, “but being unwilling to consider alternate solutions that would improve that, versus just simply dropping the price.”

A day before the transaction was supposed to close, another issue arose. The bank refused to move forward unless T. Rowe Price was in the deal, but the investor was making demands.

That didn’t feel right to him. “I was rooting for the process,” Gurley said later. “The thing that caused me to pick up the baton was this IPO.”

Stitch Fix ultimately priced its shares at $15, below its range of $18 to $20. The company raised $120 million after deciding to sell fewer shares at the lower price. CEO Katrina Lake was the only woman to lead a technology company to go public that year. The shares, which started trading on the NASDAQ stock exchange, opened at $16.90 before closing the day at $15.15.

The disappointing performance was captured by the Wall Street Journal, which cited the decision to price at $15 as “another setback for a hot startup looking to cash in on its private-market success.” Stitch Fix “stumbled in its stock-market debut,” another article in the paper said.

Months after the Stitch Fix IPO and Spotify’s direct listing, Gurley hosted a retinue of Morgan Stanley bankers including Grimes, Stewart, and Rizvan Dhalla at Benchmark’s offices in Woodside, California. They were there explicitly to discuss the subject of direct listings. Gurley had assembled Benchmark’s team to hear from them.

As Grimes began his presentation, he told the venture capitalists that he would prove to them that he knew why they liked the direct listing approach. He ran down a list of reasons and suggested that he and the other bankers in the room felt as they did. His ability to put himself in the venture capitalists’ shoes showed Gurley that the bank was at least willing to think through the topic.

“They were at least cognizant of the issues,” Gurley said later.

One of the issues that venture capitalists and company executives had with the traditional public offering was of course the large fees they often had to pay to underwriters. Typically set at 7 percent of the offering, the fee hadn’t moved much lower in years, though large issuers such as Google or Facebook could occasionally negotiate for it to be lower.

When it came time to reward its advisors, Spotify paid about $36 million to its bankers at Goldman Sachs, Morgan Stanley, and Allen & Co. That was roughly 3.8 percent of the company’s opening trade. If Spotify had instead agreed to pay underwriters 7 percent in a traditional IPO that sold 5.6 million shares at $165.90, it would have had to fork over as much as $65 million to its bankers.

In October 2018, Gurley had another run-in with Wall Street investment bankers over their handling of an IPO. Elastic was another Benchmark investment in the enterprise software industry that was preparing for an IPO led by Goldman Sachs. Gurley’s colleague Peter Fenton sat on the board. Benchmark believed the company had a bright future and could price the shares at around $80 apiece.

When it came time to price the deal, Elastic sold shares at less than half that amount, or $36. Gurley laid the blame at the feet of Goldman Sachs. Benchmark didn’t agree with the pricing and told the bank that if it was going with $36, they wanted an allocation of between $10 million and $20 million in the IPO. Goldman wouldn’t give it to them. By the time the markets closed on Elastic’s first day of trading, the stock had risen 94 percent, to $70. The underpricing cost Benchmark $60 million, the venture firm reckoned.

The Elastic experience left Gurley sour, even though it may not have been as clear cut as he thought. CEO Shay Banon spoke to Business Insider the day after the IPO and took responsibility. “As for the pricing, I decided that $36 per share was a fair price for our company.”

Gurley said Banon’s quote didn’t surprise him. “I will tell you that every single time this kind of discounting situation takes place and the press asks the CEO in the heat of the moment, ‘Did you just fuck up?’ they always say no, and I don’t know of a world where that wouldn’t happen,” he said. “You’re sitting there on the biggest day of this company’s life, everyone else is throwing confetti around.” Gurley’s big trade, Uber Technologies, stumbled out of the gate six months later. Uber sold shares to the public on May 9, 2019, at $45 apiece. The next day, CNBC featured the former venture capitalist Roger McNamee and the journalist Kara Swisher, who questioned whether Uber would ever turn a profit. The shares opened at $42 before slumping to $41.57 by the close of trading.

So as Slack neared its direct listing the following month, Gurley was watching closely.

The week before Slack’s listing, cybersecurity firm CrowdStrike Holdings Inc. held a traditional IPO. Its shares nearly doubled in a day. The performance was enough to unleash a series of tweets from Gurley, who wasn’t shy about sharing his opinions. A frequent guest on financial news networks including CNBC, since 1996 he’d maintained a widely followed blog, Above the Crowd, its title a nod to the fact that he was six foot nine. Gurley showed a talent for Twitter, too, easily touting his investments and debating financial theories in the clipped and symbol-heavy language of social media. The former basketball player also chimed in on NBA topics. Gurley had hundreds of thousands of Twitter followers who hung on his every word.

With the CrowdStrike IPO, Gurley now had reason to begin tweeting about the state of the IPO market. On June 12, he wrote, “One perspective—CrowdStrike (and other way underpriced deals) are the true definition of a ‘broken’ IPO.” He calculated how much the company left on the table by selling at a lower price in its IPO.

“Imagine if a CFO/CEO gave away a half a billion dollars?” Gurley asked. “Or simply squandered it. How would that be viewed? This is similar, but it’s institutionalized, and therefore everyone is numb to it. And the press views a ‘pop’ as success, which is just poor financial comprehension.”

His final tweet of the thread referenced Slack’s upcoming direct listing and the mechanism for setting its price. “There is no reason whatsoever [that] equities cannot be priced in a blind auction. Bonds have been priced/sold this way for decades. This is how 100% of IPOs should be done. And hopefully will one day.”

The following day, two more IPOs—pet retailer Chewy Inc. and freelancing marketplace Fiverr International Ltd.—surged more than 50 percent when their shares started trading.

By the time Slack priced its direct listing, Gurley had laid the groundwork for his next Twitter thread. Little more than an hour after the close of the trading day, he placed his cursor into a blank space and typed out a message.

In this tweet, Gurley praised the lack of volatility in Slack’s listing, which closed within 1 percent of its opening price, and name checked advisors Morgan Stanley and Citadel Securities, which handled the trading on the NYSE. And then he offered a full-throated endorsement.

“If your company is interested in a direct-listing, recommend you call Morgan Stanley,” Gurley wrote. “Other banks want to position direct listings as ‘exceptional’ or ‘rare.’ MS believes they are 1) a better mousetrap, and 2) can be used broadly.”

The message ping-ponged down the corridors of Silicon Valley and Wall Street almost as soon as he sent it. Goldman’s head of technology banking, Nick Giovanni, wasn’t happy. Giovanni, known for an intense and direct manner and a tendency to drive his people hard, headed a team that had led the IPO underwriter rankings for years. He could be difficult, but he was also talented and unavoidable if you wanted Goldman’s expertise.

Giovanni called Gurley. Goldman had been the lead bank on the two direct listings so far—why was Gurley throwing his support behind the competitor? the banker wanted to know.

“Do you know how much business that tweet might cost us?” Giovanni snapped.

Gurley didn’t want to hear it. “Nick, let me show you the Elastic math. You cost us sixty million. How much business do you have to lose before you and I are even?”

The two men spent another few minutes talking past each other until Giovanni suggested that Goldman and Benchmark should spend more time discussing Goldman’s position on direct listings. Giovanni felt that because Goldman’s take was more nuanced—it wanted what was best for the client, not a one-size-fits-all approach—it didn’t fit into a clean narrative. He told Gurley he would get back to him. Giovanni followed up with Gurley’s Benchmark colleagues. He didn’t reconnect with Gurley, the venture capitalist said.

“One of the reasons why I was very supportive of Morgan Stanley was that they would at least come and sit down” and explain the reasons why a direct listing might be preferred, Gurley said. “I had a slide that [Grimes] had given me where he wrote down the six or seven things. I don’t think that means the minute I leave the room, he’s telling every customer that same thing, but I did appreciate the candor and the honesty from Michael. Whereas I would always hear, every time one of our companies would meet with Goldman, they’d try and talk them out of a DL, every time. It’s just a little bit on the margin, but it was still something that seemed to matter, like anything that would help move us in the right direction.”

If Gurley was the only one touting Morgan Stanley, that would have been one thing. But he wasn’t. Two weeks after Slack went public, on July 2, Andreessen Horowitz partner Jamie McGurk published a blog post entitled “All about Direct Listings.”

One of McGurk’s roles was to work with portfolio companies in the process of going public, and he had worked on Slack’s direct listing, getting under the hood of the direct listing process so the firm would know how to sell its shares in the listing.

The experience made McGurk into one of Silicon Valley’s few experts in direct listings. He realized the rarity of his expertise at an event in Santa Barbara where he met a startup executive who strongly opposed direct listings. When McGurk pressed him, the executive cited premise after premise that was simply wrong. McGurk went to his hotel room almost immediately and wrote the broad outlines of the post.

The traditional IPO process was “ripe for innovation: The very first IPO technically happened over 400 years ago, and the rules for current IPOs were established nearly a century ago,” McGurk wrote. “But technology has changed since.” He cited Google’s Dutch auction and the creation of the long-term stock exchange, the first exchange headquartered in Silicon Valley. Direct listings, he wrote, could become widespread by following the same trend.

Over nearly five thousand words, McGurk told readers about his behind-the-scenes role on the Slack direct listing, explained the differences between direct listings and IPOs, and dispelled six myths about both that he had identified:

Price appreciation is the measure of a successful listing

New listings need to price at a discount to attract new investors

The IPO is a financing event

Companies that need to raise capital can’t do a Direct Listing

Public Investors don’t like Direct Listings

Only “well-known” brands can pursue a Direct Listing

“One of the greatest myths of modern IPOs,” McGurk wrote, which he said media coverage “aided and abetted,” was the belief that a surging stock price is some measure of a successful offering. The first-day pops garner a lot of attention, he admitted, but all they do is show that the stock was mispriced. Instead, the success of direct listings can be judged, he said, on volume rather than price, because a high number of trades shows many buyers and sellers coming together to agree on a certain price.

McGurk said that for Spotify’s direct listing, the stock opened on “thin volume” that led the price to drift down during the day. Slack’s opening trade was more than 45 million shares, making it one of the largest listings in NYSE history.

McGurk also tried to dispel the notion that listings must price at a discount to the company’s value to attract new investors. “IPOs currently rely on hand-picking investors,” he wrote, whereas direct listings arrive at a market-clearing price that draws in those investors who are “most aligned” with the company. As a result, the direct listing, he wrote, is a “much more egalitarian process.”

McGurk cited the conflicted position of investment banks by virtue of their role as intermediaries, which he argued had become less important over the last decade. In the past, companies needed investment banks to broker conversations with investors when mutual funds and hedge funds were “unapproachable and remote,” he wrote. Now, many of those same investors were active in private markets and were meeting executives to discuss financing rounds years before it was time for startups to go public.

The preponderance of money available to private startups had also begun to remove the importance of the IPO as a financing event, McGurk wrote. If a company needed money and wanted to do a direct listing, he suggested that it sell 2–3 percent of its capitalization in new shares in a private round to crossover investors. Those investors would remain through the listing and continue as investors in the public company. “By decoupling the [capital-raising] and the public listing, the company can better calibrate selling the right amount of shares—without discounting too much—and at the right market price.”

Despite the problems McGurk identified in the traditional IPO, he stopped short of calling for investment banks to get cut out of the process completely. The banks, whose role changes from underwriter to advisor in a direct listing, offered “tremendous value” in Slack’s listing. Morgan Stanley played a critical role in making the Slack transaction a success, McGurk wrote.

The post mentioned Morgan Stanley twice. Goldman’s name didn’t appear once.

Giovanni was once again unhappy, and he forced a colleague in charge of managing the Andreessen relationship to hastily convene a call with McGurk the following morning, July 3. Catching McGurk on vacation, Giovanni spent thirty minutes or so protesting the venture capitalist’s decision to ignore Goldman’s role leading the first two direct listings and make him look bad. Goldman was instrumental to the deal, Giovanni explained, offering as evidence the fact that Goldman made more in fees on the transaction than Morgan Stanley. The conversation was tense, and McGurk explained that he had not intended to make Goldman look bad. Morgan Stanley’s inclusion reflected the fact that Morgan Stanley’s bankers had reached out to Slack’s shareholders much earlier than Goldman had to hash out the details of the transaction. Finally, Giovanni ran out of steam and the call ended, without a resolution.

While McGurk’s post explained what many involved in the Spotify and Slack direct listings already knew, it was notable that Andreessen Horowitz, one of Silicon Valley’s most powerful venture capitalists, was lending its name to support direct listings.

Around that time, Gurley reached out to Jeff Jordan, a partner at Andreessen to learn more about the Slack listing. The two financiers knew each other from OpenTable, where Jordan had been CEO while Gurley was on the board. Though partners at Benchmark and Andreessen harbored a rivalry that could be traced back to Marc Andreessen’s grudge against Gurley over the latter’s 1997 downgrade of Netscape, personal relationships could sometimes overcome the animosity.

Jordan directed Gurley to McGurk’s blog post about direct listings and told him that he should talk to his partner. McGurk and Gurley met for lunch to discuss the listing.

Gurley was working on a plan for a daylong symposium that would educate startup executives and other venture capitalists about the direct listing process. Investment bankers weren’t invited.

In early September, Slack disclosed its first quarterly results as a public company. Revenue had risen 58 percent, and the number of paying customers had increased 37 percent, to more than 100,000. Costs had risen quickly, too, jumping to ten times the amount registered in the previous year’s quarter. This was due largely to $307 million in equity compensation costs and taxes related to the direct listing. The company continued to spend heavily on sales and marketing, suggesting that it felt the need to aggressively keep up with the competition. Slack said that it would likely suffer a bigger-than-expected third-quarter loss.

At the top of many investors’ minds was the battle with Microsoft, and the company’s press release didn’t disappoint in terms of providing fodder. Butterfield intensified his fight with his largest rival, mentioning two Slack customers who also used the Microsoft 365 Office suite. One, he said, stuck with Slack because “only Slack was capable of meeting their needs.”

Butterfield said on an earnings call that the next five years of Slack’s life would be very different from the prior five, and that the company was increasingly focused on meeting the needs of large corporations. “The transition to being a public company is just one hallmark of what we see as the company entering a new phase,” he said.

Investors didn’t like what they heard. The company’s stock price plunged about 15 percent in after-hours trading. Slack was facing tough questions about its ability to hold off Microsoft. The most obvious problem: Microsoft offered Teams for free to users of its other Office 365 products. The Teams platform now counted thirteen million daily active users, compared to Slack’s ten million.

The following day, Credit Suisse and MKM Partners analysts cut their forecasts. Citigroup slashed its price target to $27 from $39. It didn’t take long for the op-ed pages of the financial press to jump on, with both the Financial Times and the Wall Street Journal suggesting that Slack’s stock slump still had room to run. The shares closed September 5 at $30.01. That put the stock price down almost 18 percent since its opening trade in June.

Spotify wasn’t doing much better. Its stock closed the September 5 trading day at $135.68, down 18 percent from its opening price on the day of its direct listing. A few theories began to emerge. One was that the direct listing captured a broad swath of investor interest, because it was available to all investors at the same time. They could all participate in the direct listing, so there was no artificial demand created to buy the stock later in its life cycle. In that way, it succeeded in capturing a higher valuation than many IPOs, which only capture interest from a select group of institutional investors and, if all goes well, tend to rise in the months after the event.

Another theory was that investors had questions about companies’ ability to execute on their business models as publicly traded entities. Still another suggested that investors were growing bearish on high-growth, and money-losing, technology companies.

The IPO market began to bear this out. On September 11, direct to consumer orthodontics startup SmileDirect broke issue when its JPMorgan-led IPO slumped 28 percent from the $23 IPO price to close below $17 on its first day of trading. It was the worst debut for a company valued at more than $1 billion that year.

Two weeks later, Peloton held its own IPO. The stock was priced above the range, at $29, and slumped 11 percent in its debut, making it the second-worst performance for a $1 billion company in 2019.

Four days after the Peloton slump, WeWork officially pulled its IPO.

By then, Unity Software, another software firm with roots in video games had begun its early steps toward listing its shares. Its headquarters was just a short walk up Market Street from Slack’s San Francisco headquarters, in a wide box of a building that boasted exposed brick walls and timber beams.

Unity’s engineers and executives developed software used by video game developers. They made the foundation of the game, known as the engine, that handled the physics, graphics, and light effects. With Unity providing that layer, which also included tools to make money with advertisements or in-game purchases, game developers could spend less time writing code and more time designing whatever it was that distinguished their products in the marketplace. Developers behind Pokémon GO, Monument Valley, and Super Mario Run used Unity’s software.

Unity was founded in 2004 in Copenhagen as Over the Edge Entertainment to make a game for Apple computers called GooBall. When that didn’t find commercial success, the founders—David Helgason, Nicholas Francis, and Joachim Ante—focused instead on developing the software tools they created and selling them to other developers.

Over the Edge enjoyed early acclaim, earning a second-place showing in the 2006 Apple Design Awards. When Apple introduced the iPhone in 2007 and the App Store in 2008, Over the Edge moved fast to give game developers the tools they needed to distribute their games on mobile devices.

The founders moved their headquarters to San Francisco in 2009, changed the company’s name to Unity Software, and persuaded Sequoia Capital and partner Roelof Botha to lead a $5.5 million investment. With the backing of Sequoia, one of the world’s most successful and powerful venture firms, Unity focused on growth.

Five years later, in October 2014, John Riccitiello, the former CEO of Electronic Arts, who had joined Unity’s board the prior year, took over as CEO. He had a vision for how the company could support developers in augmented reality and virtual reality applications and a skill at selling investors on that vision. The company also worked with design and engineering clients looking to use 2D and 3D technology to produce renderings of large structures such as skyscrapers and interior spaces like offices or museums.

Under Riccitiello, Unity’s valuation surged to $1.5 billion. In May 2017, Silver Lake’s co-CEO Egon Durban led a $400 million round that valued the company at $2.8 billion and joined Unity’s board.

As Slack prepared for its direct listing in early 2019, Riccitiello looked for a new finance chief. Former CFO Mike Foley had left in mid-2018. After an extensive search, Riccitiello hired Kim Jabal, Google’s former investor relations chief. By the time she joined Unity, Jabal had held several startup finance roles. She’d left website creation tool Weebly, another company where Botha sat on the board, in late 2018.

Riccitiello talked up Jabal’s experience in a press release announcing her hire. “Couple her finance experience with her deep roots in engineering and R&D, and it’s no secret why she’s a great fit.” In the same statement, Jabal compared Unity to Google in its early days. “It reminds me a lot of when I started at Google, back when the company was a smaller, yet similarly positioned, and very technology-driven, company.”

Jabal would wrestle Unity’s technology systems and financial reporting functions into shape, much like McCarthy had done at Spotify to make the company ready for the public markets. And she would begin to think about how to get the company into the public markets.