Confessions of a Corporate Dealmaker

"We're the Wal-Mart of Investment Banking"

Here is a good interview with Paul Deninger of Jefferies Broadview on changes to the investment banking business that impact the IPO market.  I agree with Paul that the number one reason (I won't call it a problem as he does) IPOs are down has been the changing structure of investment banks.  I don't think SOX is as big of an issue as most people (including Paul) make it out to be, and I've been part of an implementation, so I have a pretty good perspective.  There were three key events during the last five years that heavily impacted the IPO market:

1. Regulation FD (2000) - This reg. is seldom mentioned as a woe afflicting I-banking, but it really did change the way that public companies communicated with research analysts.  Pre-FD, analysts got a tremendous amount of intelligence right from the company.  This information was worth every dime of commission the buy side paid for it.  After FD, companies seldom let research analysts meet with anyone but IR, and they established more formal relationships with analysts.
2. Decimalization and Electronic Trading (2001) - Ironically the push for decimalization was led by Rep. Michael Oxley (R-OH) - conspiracy theory?  This evolution took most of the margin wind out of the sales & trading business which was a key supporter of research.  Reg. NMS which was implemented earlier this year only further degraded the profits of investment banks' sales & trading arms.
3. Global Research Settlement (2003) - This event eliminated nearly all the revenue from research departments' budgets.  Formally separating investment banking and research admittedly ended a lot a abuses; however, it's too bad because the relationship, when done right, often worked out really well for companies.

I still think lack of demand by institutional investors is the primary reason for the dismal IPO market, but the above factors certainly contributed.

Are You Coming or Going?

I love finding new data points that combined with data I already know gives new meaning to something.  Today I had one of those eureka moments while reading Piper Jaffray's M&A Monitor.  If you're going to assess the IPO market you can't just look at it from the perspective of companies trying to go public.  You need to asses the other side too.  SEC form 13E-3 is what public companies file when they decide it's time to go private.  Eureka!

Revenue to go Public

Devin in Salt Lake City asks an excellent question, "How big [I assume you mean revenue] does a company have to be to go public today?"  Well, I like numbers because they've never lied to me, so let's let the stats answer the question.  I analyzed just the 13 tech IPOs in 2005 (there were 41 total, but I'll let you do the rest Devin) and found:

• Average TTM Revenue Prior to IPO = $82.6 million
• Average Quarterly Revenue Growth (YOY) Prior to IPO = 39.3%

Here is what's interesting to me - based on my quick analysis of the current valuation multiples for the class of 2005, only 60% are trading above were they would have likely been sold.  So the question I have is why risk it?

The IPO Market is Right Where it Should Be

Catching up on my reading of some of the trade rags I get yielded this yesterday -

From the head of a venture industry trade association:

For the IPO market to improve, we need relief from certain hurdles associated with the Sarbanes-Oxley Act, but we also need an investing public that is bullish on technology.

SOX is not the problem, companies going public too early, missing their numbers and going belly-up was the problem (unless you want to blame the investing public for having long memories).  Looking at the multiples of leading public tech and bio-tech companies compared to other sectors, I would say that the public is pretty darn bullish.

NOTE TO VENTURE CAPITAL AND INVESTMENT BANKING INDUSTRIES: 1999 IS OVER, AND IT AIN'T COMING BACK.  THE IPO MARKET IS RIGHT WHERE IT SHOULD BE.  REMEMBER THESE NUMBERS: 400/90/10 (400 EXITS PER YEAR, 90% M&A, 10% IPO).

Here's another headline from an industry trade rag (guess I won't be speaking at their conference this year):

Despite a decline in startup financings by venture capital firms [in 2005]... alongside the dearth of exit opportunities, venture capital partners in Silicon Valley remain bullish ... in 2006 ....

Wait a minute, the industry numbers show stability for both venture deals and total venture capital invested for the last four years - about 3,000 deals raising approx. $20 billion per year.  In addition, over the last five years the venture exits (IPO and M&A) have been about the same, around 400 a year (ah, but you remembered that).

Look, if you're a venture-backed entrepreneur don't waste your time thinking, considering or worrying about going public, it will probably never happen to your company.  Spend your time and effort preparing your company for an acquisition.

Will the IPO Market Come Back?

People ask me this all the time.  I guess because my world straddles institutional investors and venture-backed companies.  I will say the that the II's are indifferent while entrepreneurs and VCs tend to be scared, upset, concerned, confused, etc.  I say the IPO market is back and right were it should be.

If you stop listening to the stories, rhetoric, rumors and Chicken Littles and begin looking at the facts, I think you will see why.

I took the VentureOne and PWCMoneyTree final numbers for 2005, and put them together Download venture_one_2005_liquidity.pdf .  I consider the sale of a company and a IPO to be the same thing, an exit (liquidity event).  An IPO is not a financing event like its brothers follow-on and secondary offerings, it is the transfer of ownership just like a M&A transaction.  Therefore, the data tells us we've had about the same number of exits for the last five years - about 400 and close to that in 1998.  Over time what has changed has been the ratios and the valuations of those exits, but what hasn't changed is the number of exits.  When the IPO market is down the M&A market picks up the slack.  Granted we've had some years when the number of exits and IPOs have dramatically increased, but that's not the norm.

Unfortunately, a lot of entrepreneurs and some VCs I talk to like to hope or believe that 1999 was what the norm should be.  That's nice, but it's not.  Historically the data says it's not and probably won't be in the future.  It is most likely that in the future, just like in the past, only about 10% of exits will be IPOs.  So the IPO market is back to it's normal state of being.

Smart companies realize this and manage, structure and position themselves to be bought not go public.

Buried At The Back

I finally got time to review the VentureOne liquidity data from 2005.  An interesting data point in the accompanying press release (dated 1/3/06) is the very last sentence (which is the only thing to appear on the last page (page 4)).  The press really picked-up on the release, but I haven't heard anyone talk about this:

The median time between initial equity financing and acquisition in 2005 was 5.4 years - the longest period in more than a decade, and almost a year longer than acquired companies in 2004.

For those of you keeping score at home, 2004 was 4.6 years and 2003 was 3.6 years.  Now I'm not a big fan of the use of median for data like this, as I think mean might have been more meaningful (sorry!).  I think V1 should show both (anyone at VentureOne reading?).

Anyone want to speculate why the increase and what it means?