Why Education Startups Rarely Go Public

Because of the way education markets function, scaling and growth are daunting tasks, and many startups get bought up by the old guard of education before they become a competitive threat.

The public debut last week of education technology company 2U, which partners with nonprofit and public universities to offer online degree programs, may have looked like a harbinger of IPO riches to come for companies that, like 2U, promise to disrupt the traditional education industry. At least that's what the investors and founders of these companies want to believe.

But that's not looking likely.

While ed-tech startups have been among the hottest companies for venture capital investment — nearly half a billion dollars was pumped into those startups in the first quarter of 2014 alone, according to data from Crunchbase — getting to the scale necessary to IPO is a rarity, not the norm. 2U is just the third venture-backed ed-tech company to make it to IPO in the last five years, according to a Wall Street Journal article.

More likely is that these "disruptors" get acquired by the very companies that they are trying to disrupt — well before they become a competitive threat. And those that don't get bought often end up floundering without the contracts or revenue they need to survive.

"We live in a post-Facebook area where startups have this idea that they can design a good product and then just grow, grow, grow," said Phil Hill, an education technology consultant and analyst. "That's not how it actually works in education."

Because of the way the education markets function, with school districts and universities deciding what technologies to adopt and when, scaling and growth are daunting tasks. Districts already have established relationships with large companies and are reluctant to take risks on new, young technologies. Things are also riskier and more volatile in education because it's such a highly seasonal business, concentrated around when teachers and schools do their purchasing around the beginning of the school year. A company that falls short of contract goals could be forced to wait another six months, or even a year, before it gets another opportunity to bring in revenue — a wait many startups can't afford.

"People are going to realize that it's going to be difficult to get an ROI on ed-tech," said Hill. "In the next two years, you're going to see a lot of companies going out of business, and a ramp up in big companies acquiring the small ones that are left."

The big three of education — Pearson, McGraw-Hill, and Houghton Mifflin Harcourt — still basically control the business. Together, they own about 85% of the K-12 textbook market, and also develop tests, content platforms, and curriculum. They're big players in higher ed as well.

But the print textbook industry has been in rapid decline, taking a toll on those companies' central businesses. Pearson's stock fell sharply in January after its 2013 earnings were much lower than expected; McGraw-Hill was spun off of its financial arm and bought by a private equity firm; and Houghton Mifflin emerged from bankruptcy in 2012. Even outside of the textbook industry, control is concentrated in a small number of companies, all of whom are struggling to stay afloat. Blackboard is among the giants of learning management systems, but its market share is slipping, and after going public in 2004, it was taken off the market in 2011 by a private equity firm.

What it all amounts to is this: The old guard of education is hungry, even desperate, for new, fresh ideas, and ed-tech startups make for appetizing, and vulnerable, acquisition targets.

Take, for instance, the ed-tech startup Chalkable. Founded by Michael Levy and Zoly Honig, Chalkable's aim was to displace Blackboard. Honig told BuzzFeed that he and Levy felt Blackboard's system was weak and that they could do a better job with the technology. They designed what is essentially an app store for learning tools, allowing teachers to easily search and integrate top programs.

But Chalkable struggled to grow, especially when it came to accessing student data, which is stored in a variety of complex backend systems produced by different companies. At first, Honig said, their goal was to build their own backend system, much like Blackboard: "We thought we could just do it ourselves. We never thought about merging." But they quickly realized that building their own system was a lot more complicated than it seemed, and getting school districts to adopt the system would have been even tougher. Honig said they next tried forming partnerships with already-existing systems before realizing that selling "was what made sense."

Chalkable ended up being bought for $10 million by STI Education Services Group, a 30-year-old maker of education data systems — the very ones that Honig and Levy needed access to — that was trying to diversify its technology. Chalkable, for its part, transformed STI from a backend data system into a more capable learning platform post-acquisition.

Almost every major company in the education sphere made acquisitions last year, and dozens more have been made already in 2014. The biggest buyer by far, according to informations services firm CB Insights, was Pearson, which bought 12 companies in 2013.

"We quickly realized that there's a lot of innovation going on that could be really beneficial to Pearson," said Diana Stepner, who was brought on in 2011 to run the company's "future technologies" team. With an eye toward partnerships and acquisitions, Pearson began its own accelerator, which graduated its first class of five startups last year. Four, Stepner said, are now in "stages of further discussion" with the company.

"It's interesting to watch a startup be able to get to a certain point and then just hit a barrier," Stepner said. "They can't get out of their local area, because there are so many nuances from state-to-state, and so many barriers to adoption. That's where Pearson can come in with our connections."

Those connections, primarily already-established relationships to school districts, are absolutely vital to most startups, especially if their products involve one of ed-tech's biggest new trends, working with student data.

Some startups, bucking at the idea of being acquired in order to achieve growth, have tried bypassing deals with districts and going directly to teachers. The problem with that is that it means the services must be offered for free: teachers are generally unwilling (and unable) to put their own money into their classrooms.

The primary example of that model is the hugely popular venture-backed Edmodo, a classroom management tool for teachers that has eaten away drastically at a market once controlled by Blackboard and an open-source platform called Moodle. Edmodo even made its own acquisition last year. But the company has yet to monetize in any significant way, and because it has to keep its product free, its plans to do so are vague.

"I think the majority of startups are thinking about acquisition," said Margery Mayer, the head of the education division at Scholastic. "That's the best way most of them are going to make money."

As for 2U, its stock has remained essentially flat in its first week of trading. After making its debut at $13.89, it hovered at $13 Friday morning.