Implosions at Facebook, Groupon Are GOOD for Tech Startups

Groupon (NASDAQ:GRPN) is off 85% from its highs after a 2011 IPO. Zynga (NASDAQ:ZNGA) is off about 75% from its peak. Facebook (NASDAQ:FB) is roughly half of its offer price.

And presuming you don’t own stock in these picks, you should consider that a good thing.

Peter Thiel Unfriends Facebook

Why? Well, because maybe the painful lessons of these companies will be a wake-up call to the crazed world of startups and IPOs.

A few weeks ago, Bill George wrote a great column in Dealbook about how “an aggressive approach to early-stage venture investing has led to a bubble in start-up financing.” In a nutshell, investors and many entrepreneurs are looking to the IPO as the end of the tunnel, when in fact the goal should be future growth and long-term staying power.

I agree. Entrepreneurs and startups who truly believe in their long-term success should avoid going public as long as possible, until they can sell their actual business instead of their potential. And rather than try to get paid by chasing the best IPO price and the greediest backers to get them there, startups are best served by finding funding — and business intelligence — from backers that are interested in their particular company and the long-term success of their products or services.

Chasing the IPO instead of building a business is just plain bad. It’s bad for investors, as we’ve seen with the disasters of fashionable but insubstantial companies like Groupon. It’s also bad for execs at legitimate companies like Facebook, which get crippled by distractions about share price when they should be leading the company to growth.

Think of it this way: If all things were equal but Groupon stock popped 150% after its IPO, would it be a “stable” business? Hardly. GRPN faces the simple challenge of achieving profitability as heavyweights Google (NASDAQ:GOOG) and Amazon (NASDAQ:AMZN) get in on the daily-deals game. The movement after the IPO is irrelevant to the operations of the business.

You might say that operations and IPO performance go hand in hand, since markets are watching the balance sheet and prospects too. Fair point. But it’s hard to argue that the perspective of IPO investors these days is decidedly short-sighted. And startups can’t afford to manage their business quarter to quarter if they ever want to become legitimate businesses or (hopefully) large-cap players with a dominant brand.

Besides, small businesses and startups are an essential part of the American economy. The creative destruction of capitalism all but guarantees the old will give way to the new — take Blockbuster and Borders dying in a digital age, and the rise of Netflix (NASDAQ:NFLX) and Amazon as respective alternatives. The only way the economy refreshes itself is to have some new business in the pipeline that will recreate a product or service — or ideally, as in the case of Facebook and social media, create a whole new market.

Now more than ever we need to worry about what businesses are going to lead the American economy in 10 or 20 years. We need to encourage entrepreneurs to do what’s best for their business, not for their IPO. And we need to be long-term partners in the startups that might recreate the business world a decade down the road, not short-term investors looking to get rich quick and burn things down in the process.

It’s painful for a company like Groupon or Facebook to be hung out to dry so soon after its IPO. But maybe it’s a wake-up call for entrepreneurs everywhere, and we can start focusing on building businesses.

Of course, considering the drought in the IPO market, we might not get the chance to get it right anytime soon … but I hope the lesson rings true when public offerings pick up again.

Jeff Reeves is the editor of InvestorPlace.com and the author of “The Frugal Investor’s Guide to Finding Great Stocks.” Write him at editor@investorplace.com or follow him on Twitter via @JeffReevesIP. As of this writing, he did not own a position in any of the stocks named here.