The death and resurrection of the tech IPO

By Eric Auchard
May 1, 2009

ericauchard1– Eric Auchard is a Reuters columnist. The opinions expressed are his own –

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)

5 comments

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Interesting comment but the IPO has nothing to do with the current state of Venture Capital firms. First is their reputation as arrogant. Someone gets lucky by selling Paypal to eBay and all of a sudden they think they are an expert in every area of investment. So they end up in goofy flops like the Tesla car, and worse, the old boys VC club follow like lemmings over the cliff. Arrogant, because none even have the courtesy to acknowledge an inquiry for investment. Foolish because VCs design such convoluted and elaborate legal agreements that founders have no chance of conveying their vision in corporate growth, are forced out by the VC and subsequently over 9 of 10 VC investments fail. Dumb because those 9 losers where selected from a couple thousand inquiries which included many bona fide winners. If you were only right 10% of the time, could you hold your job! Dishonest because they will never tell you the truth about why they did not consider an investment.Frequently its because they have no money. There are some 6,000 so called funds in the country yet maybe 10 do 90% of the business. They are also no better than the hedge fund and derivative managers who have caused the current economic crisis — VCs just want to grab an idea, promote the heck out of it, do the IPO and run. Sorry guys, as Eric points out those days (hopefully) will be gone for good. If you are an entrepreneur looking for funding, find out exactly how many deals they have done in the last 12 months, what each deal was, and for how much. Ignore completely how much they claim to have under management because its all smoke and mirrors. Look for government funding, strategic alliances, and other sources of funds. And when you shake the VCs hand good-bye, check to make sure you still have your rings and watch on.

Posted by JJ Jackson | Report as abusive

i see analysis as a major hurdle to small-cap IPOs. sensible investors will not buy a stock without the availability of independent analysis, and nearly no investor can afford to pay for their own analysis on a small cap stock. brokers cannot afford to pay for analysis for their clients because transaction fees are so low that analysis of a small-cap low trading volume stock won’t pay for itself. no investment bank will IPO a stock for which there is no aftermarket, and with no independent analysis i believe it is REASONABLE that there is no aftermarket.

Posted by bill topp | Report as abusive

I agree with you when you say VC’s are there own worst enemy and copycat policy as alternate to funding innovative patent protected ideas. This has largely emerged through the death of enforceability of US intellectual property in a Globally Networked Economy who’s primary success is represented in an Ad-Based property system that needs all property to be free to continue to grow. Resultantly primary VC providers like Sequoia Capital find it in their best interests to co-create platforms by shorting US Innovation through Intellectual Property Piracy, re-distribution in Israel and China while attempting to benefit from Offshore (and in some cases benefiting unregulated HEDGE FUND INTERESTS) in a Tax Free carribean environment.

The true US Innovator in the historic sense of the word, is unprotected in its entirety and from the moment an entrepreneur goes out seeking capital, a Network is laid out that is more capable and better rewarded through taking innovations from the innovator, partially developing in low-cost environments and rewarding Non-Taxpayer offshore interests with IPO Returns.

Ultimately examples like YOU TUBE which will come to be known as the most successful PIRACY BASED VENTURE of all time tell a secret story of the business of theft going international and drawing in players that are unregulated in every sense.

This will add to regulation of VC’s and their investors and higher costs of going IPO.

There is nothing wrong with tailoring a business for sale to another, there is something wrong with Siezing the Assets of an Entrepreur, repackaging and developing them to benefit tax free offshore entities and merging it into a US PUBLIC COMPANY for $1,650,000,000.00 when you did not own the property on which the venture was based and the purchaser had full knowledge having provided the theft of that property to the development partner, having stole it in the first place.

These are Big Numbers and Big Numbers attract Criminality when in Unregulated Systems.

Ultimately US Venture Capital needs to be our most highly regulated industry, where the Property Protection Offices and SBA function as an incubator protecting the developer from the rampant whitecollar IP PIRACY crimes that have come to surround these markets.

Real innovators never make it to the market, as if their idea is strong enough they’re robbed in the ‘LOBBY’ OF THE BANK.

True story.

Corruption and deceit killed the goose. Better hope she had a gosling that can make it to maturity.

Posted by Anubis | Report as abusive

By the way, I don’t believe in the resurrection of Jesus, Krishna or Ossyrus/Horace. Why would I believe in the resurrection of any financial mechanism or industry. Is the fertility cult of the “Bull” some religious metaphor for “Bull Market”capitalism? Or is it the other way around?

Posted by Anubis | Report as abusive