The death and resurrection of the tech IPO
The U.S. venture capital industry is desperate to repair the market for initial public stock offerings, but reviving the goose that once laid hundreds of golden eggs may not get very far.
The National Venture Capital Association (NVCA) this week set out its comprehensive plan to revive the IPO market and the heady investment returns that once fueled the tightly knit venture capital industry’s success.
From October through March, there were no venture-backed IPOs in the United States — the first time on record of no venture IPO activity for two consecutive quarters.
The NVCA plan is entitled “The 4-Pillar Plan to Restore Liquidity to the U.S. Venture Capital Industry.” Institutions at every step in the process that turns bright business ideas into publicly traded companies come in for criticism for the decline of the IPO market.
But start-up entrepreneurs and their venture capital backers largely have themselves to blame for why public markets have become gun-shy about buying into IPOs.
There is now a noticeable dearth of entrepreneurs building companies with differentiated strategies and sustainable business models. Hot start-ups are now far more often built to be sold to established firms. And when good ideas emerge, VCs flood the market with a slew of copycats, making it hard for true pioneers to succeed.
Some of the hottest start-up sectors — the Internet, and cleantech — continue to ignore the need for a demonstrating a clear track record of sustained profits and defensible barriers to entry by competitors.
The exceptions where this entirely fair generalisation is wrong deserve to become the next successful IPOs.
Look no further than the hottest companies in Silicon Valley — social network site Facebook and text messaging service Twitter — the subject of widespread media speculation that they and their venture backers may seek to stage high-profile IPOs next year.
Both companies’ strategies have been to build huge audiences and only later to figure out how to generate revenue, profit and a sustainable business model. Fattening up and selling the companies themselves may be the business strategy.
Big banks have all too often worked against the long-term success of IPO companies by reserving the hottest shares for favoured clients, many of whom were hedge funds or short-sellers — whose objective was in quickly flipping or selling out.
Regulators intent on preventing the next Enron, Worldcom or Parmalat by breaking down the cosy relations between bankers and research analysts have meant that many small and mid-sized companies receive little analyst coverage once public.
On the receiving end of IPOs, committed buyers are in short-supply. Many investment managers that once bought IPOs by the bushel now run funds too large to make the effort to trade small companies. New funds devoted to technology, cleantech, and other emerging business sectors need to be formed to take up the slack.
With their plan, venture capitalists are looking to counter criticism they can work against the interest of public investors when they sell off ownership stakes too quickly after companies in which they have invested hold IPOs.
One NVCA proposal calls for VCs to consider accepting longer lockups on their holdings once their portfolio investments go public. This measure could go some way to restore confidence that venture capitalists can behave as patient investors.
The VCs want regulators to reduce burdensome compliance requirements that cripple the ability of small companies to raise public financing and asks for one-time only low capital gains tax rates to jump start the IPO market, perhaps in exchange for investors agreeing to longer-term holding periods.
Nonetheless, the IPO market is a cyclical one that has every sign of springing back to life once the current financial crisis subsides. In just the past few weeks, a trickle of successful new stock offerings has encouraged renewed speculation that the window for IPOs may open more broadly in 2010.
Reform or no, the IPO drought is bound to recover simply because the lack of supply eventually breeds pent up demand for new issues.
This is born out by data. After the decline in IPO activity earlier this decade following the Internet stock boom of the 1990s, 2007 marked the best year of IPO activity since 1996, outside the bubble years. And 2008 was on track to be even stronger for IPOs until the financial crisis hit home.
This crisis is itself creating conditions for another class of IPO darlings, but whatever transpires is likely to be a far cry from the IPO Golden Age for which VCs yearn.
(Editing by David Evans)