The Real Meaning of Etsy’s Initial Public Offering

Etsy’s decision to go public seems to have unleashed a wave of jokes about Portlandia, yarn crafts, and Brooklyn hipsters on Wall Street. Go ahead and get it out of your system, and when you’re done consider for a moment what this stock offering, which could come as early as April, will mean for the tech IPO market at large.

Founded in 2005, Etsy has aged better than many of the startups that have emerged during the past decade, like Yelp or Groupon. With revenue still growing close to 60% a year, the company seems to have a fair amount of gas in its growth engine. That’s because Etsy was designed to do something that didn’t really exist at scale before: create a marketplace devoted to connecting those who love to make handcrafted goods with consumers who love buying them.

Etsy’s origins lie in real-world craft fairs, tightly connecting the creators who drove the maker movement in ways that a broader marketplace like eBay couldn’t. The marketplace charges sellers a 3.5% fee on completed transactions plus a 20 cents per item to list fees on the site for four months. Sellers can also pay extra for shipping labels, direct checkout and promoted listings, and these value-added services now make up 47% of Etsy’s total revenue.

But while Etsy is one of the more successful communities to have emerged on the Internet in the past decade, it’s not exactly counted among the so-called “unicorns”, the rare and wildly popular startups, like Uber or Airbnb, that can raise megaround after megaround of private financing, skirting the need for an IPO and all the regulation and scrutiny that come with a publicly traded stock.

When Etsy filed its S-1 Wednesday, it became clearer why. Airbnb is reportedly near a $20 billion valuation, while Uber is valued at twice that amount. Etsy didn’t indicate what the company may be worth after its IPO, but it’s hoping to raise $100 million, and given that many Internet IPOs float only 5% or 10% of their outstanding shares, that could lead to an IPO that values the company between $1 billion and $2 billion.

The Etsy offering could be an important testing of the IPO waters for other companies that have growing businesses and devoted followings, but that are not able to secure large rounds of private financings. The coming months may well see more of these companies seeking IPOs if US interest rates begin to edge higher. That could bring an end to the six-year stock rally, prompting investors in both public and private markets to be choosier about where they put their money.

For Etsy, the challenge is in extending the growth in its core market to a broader range of consumers. Nearly 80% of Etsy’s sales come from repeat buyers, many of whom prefer to buy from individual producers. Etsy has 1.4 million active sellers, 95% of them running Etsy shops from their homes.

To keep growing, Etsy has had to implement changes that have alienated some longtime sellers, like expanding from handmade goods to those manufactured in small batches. And it’s decided it can’t rely mostly on the word-of-mouth referrals that drove its early growth. As a result, Etsy’s spending on search engines and other kinds of marketing rose 122% in 2014 to $40 million.

That aggressive spending caused Etsy to swing from an operating profit of $733,000 in 2013 to a $6.3 million operating loss last year. Despite the loss, Etsy still generated $12 million in operating cash flows. Meanwhile, the company’s cash on hand increased to $70 million at the end of 2014 from $37 million a year earlier. Both figures are indications of healthy business operations.

The prospectus, however, also warned of two “material weaknesses” in the way Etsy controls its financial reporting—one related to how it accounts for certain unnamed expenses and another related to “period-end accruals.” It’s not clear that either will lead to a restatement of earnings, but normally companies wait until these kinds of financial kinks are ironed out before going public. The presence of these disclosures may suggest Etsy is under pressure to complete its IPO quickly.

Another question is how Wall Street will receive Etsy’s corporate idealism. Unlike Groupon, Etsy doesn’t play up its quirkiness—a streak of humor that ultimately fell flat with investors—but its prospectus makes clear it marches to the beat of its own drum. The company’s name is taken from a phrase repeated through Fellini’s 8 ½, and its independent spirit remains strong today.

Which is why Etsy’s S-1 contained sentences like, “We eat on compostable plates, and employees sign up to deliver our compost by bike to a local farm in Red Hook, Brooklyn, where it is turned back into the soil that produces the food we enjoy together.” Or the risk factor that the company’s “focus on long-term sustainability” may hamper its short-term performance.

Google and Facebook both issued such warnings, but Etsy is raising the ante by citing sustainability and environmental concerns, rather than innovation, as the long-term objective that weigh on short-term profits. These goals are laudable and worthy in the real world, but inside the rarefied, profit-obsessed realm of Wall Street they will either be glossed over—or zeroed in on when it comes time to cut costs.

For now, though, Etsy is likely to receive a warm welcome on Wall Street. Internet IPOs with brand names familiar to consumers are a rare item these days, unlike the legion of obscure if promising drug startups. Etsy’s first test will be in showing that the spending on marketing is translating into new and loyal users. Handcrafted goods are as old as commerce itself, and Etsy has given them a modern twist. Whether that can scale up to a mainstream market remains to be seen.