Kentucky Derby vs. IPO
May. 2, 2019 Article

What Does the Kentucky Derby Have to Do With an IPO? Surprisingly, More Than You Think...

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Every year on the first Saturday in May, 20 horses line up in a starting gate for what may be the most exciting two minutes in sports. The Kentucky Derby is one of those timeless traditions in sports and entertainment that walks a line between prize money and pageantry, with one clear winner emerging from the pack and sometimes a very large payout.

By comparison, while there are no garlands of roses provided to the founders of successful companies that are taken public via an Initial Public Offering (IPO), there is the potential for a very large payout for a select few shareholders. At the same time, these individuals can be the exception rather than the rule. There are far more chances to lose money by investing in a startup company than there are for multi-million-dollar payouts. Many of the same principles and concepts prevalent on Churchill Downs draw direct comparison to the challenges and struggles a company must face in growing and navigating the public offering process.

Preparing for the Big Day

Impending IPOs from high profile tech companies including Uber, Lyft, Palantir Technologies and Pinterest have captured the attention of the investing public in recent months. While these companies now sport multi-billion-dollar valuations, they were at one-point simple startup companies funded on comparatively shoe string budgets. In addition, many of these now massive companies had founders who had previously created and exited successful businesses, only to go on to find an even larger, more successful one afterwards.

Preparation for the Kentucky Derby is similar in that many of the odds-favored horses featured in the Derby were bred and prepared specifically for that purpose. It’s not uncommon for foals purchased from good blood lines to cost several thousand dollars, but that large investment could be worth it if the horse is able to capitalize during its racing career in total prize winnings. Then if a horse wins, it has even more earning potential in breeding. According to the New York Times, American Pharoah, who won the first Triple Crown in 37 years, has stud fees starting at $200,000. A horse like this can breed more than 200 mares in a season.1

The same applies to horse trainers. Names like Bob Baffert become synonymous with multiple Kentucky Derby wins.1 Unfortunately for an investor, none of these elements guarantee a positive return. It’s possible a horse could be a total bust in much the same way that investing in a startup technology company could be a total failure if they are unable to find an audience, scale the business, or reach profitability.

The Odds

In an effort to increase the odds of success, whether for a promising young company or a young horse, considerate investing is key. Even then, the odds are long. In a study of 1,100 tech companies from 2008-2010, only 48 percent of companies raised any money beyond their initial round of fundraising.2 Over time, 67 percent of the companies studied ended up dead or merely self-sustaining, meaning that while they were profitable, it was by no means a home run for investors. 

Thoroughbreds produced for racing share similarly daunting statistics, making it rare for them to even appear on a race track. It’s estimated that 100,000 horses are bred worldwide each year for racing.3 Some rough math would then indicate that there is a 0.02 percent chance of a horse appearing among the 20 Kentucky Derby entrants in a given year.4 In order to increase those odds, horse and stable owners will employ a small army of trainers and staff to tend to the horses throughout their first few years.5 While these costs are necessary, they can add up quickly and it’s not uncommon for annual expenses to approach $100,000 for the care of a horse once training, veterinary care, insurance, farrier fees (horseshoeing) and race entry fees are added together. 

As startup companies grow, they also require significant investment, typically raised over a series of fundraising rounds. For a company to get that far, it could be considered an achievement. Only 30 percent of young businesses make it to a third round of funding and only 3 percent make it to a sixth round.6 Granted, some companies are also acquired or merge with other firms during these rounds, but the odds are still daunting. In the end, only 1 percent of companies go on to achieve “unicorn” status or a valuation of over 1 billion dollars.7 Of those companies, only a few may go public in a given year. While these major tech companies grab headlines for their IPOs, it’s important to maintain perspective on just how rare it is to reach that point in business.

From Starting Gate to Finish Line

Ryan Eatherly, a director and senior wealth advisor in Mariner Wealth Advisors’ New Albany office, grew up in Louisville, Kentucky. He knows far better than most the paradigm between betting on a racehorse and investing in a risky startup company. 

“I grew up in Louisville, so the Derby has always been part of my life. I love the pageantry that comes with it, but it’s important that you don’t let the excitement of picking the one winner cloud your judgement about the possibility of picking one of the 19 losers. Much like an IPO, you have to consider the possibility that your horse won’t be the winner and understand the effect this will have on your financial plan,” he said.

When looking at the headlines about upcoming IPOs, remember the odds of those companies getting to where they are today were long. The odds will continue to be so even after going public. Approximately 60 percent of 7,000 IPOs tracked from 1975 to 2011 went on to have negative absolute returns five years afterwards.8

Similarly, in the Kentucky Derby, only one horse will emerge as the winner. While the favorite has won the last few years, there is always the possibility a 50-1 winner, like Giacomo in 2005 or Mine that Bird in 2009, could defy the odds and emerge victorious.9 As a result, it’s important to remember that with any speculative investment or wager, taking into account an individual’s overall financial picture is crucial to determining the efficacy of that use of funds. Tuning out the financial news on IPOs or the flashy advertisements for the Kentucky Derby may be difficult, but sometimes doing so is a more productive investment of time.

 

1 https://bleacherreport.com/articles/1602236-ranking-the-10-smartest-trainers-in-horse-racing#slide9

1 https://www.nytimes.com/2018/05/04/your-money/horse-breeding-kentucky-derby.html

2 https://www.cbinsights.com/research/venture-capital-funnel-2/

3 https://horsefund.org/horse-racing-breeding-by-the-numbers-part-1.php

4 https://horsefund.org/horse-racing-breeding-by-the-numbers-part-1.php

5 https://www.nbcsandiego.com/news/sports/NATL-From-Purchase-to-Post-The-Price-of-Raising-a-Racehorse-202723931.html?amp=y

6 https://www.cbinsights.com/research/venture-capital-funnel-2/

7 https://www.cbinsights.com/research/venture-capital-funnel-2/

8 https://www.cnbc.com/2019/04/03/dont-be-fooled-by-the-unicorn-hype-this-year-most-ipos-lose-money-for-investors-after-5-years.html

9 https://www.washingtonpost.com/news/fancy-stats/wp/2018/05/04/a-case-for-each-of-the-50-1-long-shots-in-the-2018-kentucky-derby/?utm_term=.3459501ae713

The views expressed are for commentary purposes only and do not take into account any individual, personal, financial, or tax considerations. It is not intended to be personal, legal or investment advice or a solicitation to buy or sell any security or engage in a particular investment strategy. Consult a professional for specific information related to your own situation. 

Mariner, LLC dba Mariner Wealth Advisors (“MWA”), is an SEC registered investment adviser. Registration of an investment adviser does not imply a certain level of skill or training. MWA is in compliance with the current notice filing requirements imposed upon registered investment advisers by those states in which MWA maintains clients. For additional information about MWA, including fees and services, please contact MWA or refer to the Investment Adviser Public Disclosure website. Please read the disclosure statement carefully before you invest or send money.