Where are the IPO’s

Given where we are in the market cycle, we should be seeing explosive growth in the IPO world. The Dow has set a new record high, high profile acquisitions like YouTube are providing lucrative exits and the economy continues to walk the fine line between inflation and recession. These bursts of activity are the life blood of venture capital where years of toil are rewarded with big IPO paydays.

So, where are the IPO’s? Over 500 venture backed companies went public in 1999 & 2000 and throughout the 1990’s, on average, 150+ companies a year went public. Through the third quarter of this year, less than 40 companies have gone public. This is on track to match 2001 when it looked like the wheels were coming off of the economy. Additionally, many legendary investors like Julian Robertson (of Tiger Management fame) are going heavily into cash in expectation of a tough 2007-8.

On the other end of the pipeline, VC’s in the valley are putting money out like there is no tomorrow. Many went back to market in 2004-5 to raise significant funds. Post-bubble, many swore off large funds and cut back their fund sizes to $300-400m, stating that is what could logically be invested. By 2003, they were feeling more confident in the world and most bumped up their funds to $500-700m. As in 1998-9, they have quickly deployed these funds and are coming back to market in 2007 for even larger ones. VC’s have pumped over $20B into companies this year. While this is significantly below the $100B of 2000, it is twice the “steady state” rate of $10B many feel leads to sustainable solid returns.

There are two reasons for the decline in IPO’s. One is that entrepreneurs are chosing  to go the acquisition route and the other is that the markets are still weary of the small, high growth technology companies.

While acquisitions often yield just 70% of what an IPO might, they eliminate several issues associated with going public. 1) you avoid the 6-12mo lock-up while also locking in a value, 2) you avoid the hassle and costs of SOX compliance. It is estimated that these annual costs run north of $2m/year and 3) you avoid the Fair Disclosure and option pricing risks. More and more firms are looking to the AIM in London or the Asian exchanges for exit versus the Nasdaq.

So,
1) VC’s need to show restraint in how much capital they raise and how quickly they put it out. This is unlikely, unfortunately, when they can raise $500m every two years, locking in $15m/yr in management fees for each.
2) Entrepreneurs need to focus on building businesses for the long-run and no for the flip (which is back in vogue). This means getting to breakeven as soon as possible while also raising moderate amounts of capital (less than $15m).
3) Firms that are not breakeven should raise enough capital (or maintain enough capital) to credibly reach breakeven.
4) we need to overhaul how we regulate our smaller companies versus our larger ones.