Bar Lowers for Tech IPOs, as Investors Say Bring ’em On

Last week, six companies went public. This week, another dozen companies are slated to IPO, including NeoPhotonics and Epocrates, two companies whose highly anticipated offerings are expected to perform well.

If that sounds like a lot of activity, it is. In fact, it’s the busiest week for U.S. IPOs since 2007. And the trend looks to grow more pronounced thanks to  LinkedIn’s recently filed S-1, a document that many have already pored over with the same anticipation and intensity as some Wikileaks’ dispatches.

To gain better perspective on what’s happening in the broader market, I talked with Scott Sweet, senior managing partner at 6-year-old advisory firm Sweet shared some interesting thoughts about LinkedIn, what’s wrong with biotech startups, and how long it’s been since anyone expected a pre-IPO company to produce a certain amount of revenue.

Q: We’re just one month into 2011, but it feels frothy already. How does the pipeline compare with last year?

A: The numbers are high, but they’ve been higher.  At January’s end, 166 companies had registered to go public. It was as high as 185 companies at one point last year. But some of those will never come out; they’ve been dormant and they’re growing moss, but they’re staying in the pipeline, hoping on a wing and a prayer.

Q: That doesn’t sound great. Where’s the biggest problem area?

A: There are still a lot of biotech companies looking for the public markets to fund their R&D, and they’re still the worst performing. There are seven of them scheduled for this week and I question whether two or three won’t get their filing range cut in half.  People don’t want Phase 2 and Phase 3 companies when they can have reasonably priced biotechs with actual, bona fide products that are in use today. [Investors] don’t want to tie up their money.

Q: Why are bankers still taking out these startups if the market isn’t receptive?

A: They’re getting pressure from the biotechs because the biotechs are running out of money. It used to be that a lot of them would sign collaborative agreements with Pfizer and Merck and so forth, and that’s not happening, so they’re cash poor and their burn rate is too high. So they can file at whatever number, but if they have to take $4, they will. They need the money that bad.

Q: It seems like tech companies are faring much better, generally speaking.

A: Yes, tech is the best-performing sector, not only in overall performance, but tech represented the largest amount of companies brought public last year, and I envision the same will be true this year.

Q: What do you think the impact of LinkedIn’s filing will be on the sector?

A: I expect that it will do exceptionally well and that it will invariably bring other, similar companies public. It was almost like the big names — Twitter, Facebook, Zynga and Groupon — have just been waiting for somebody to take the plunge and to see how the market reacts. But there’s been nothing but positive chatter about LinkedIn’s offering.

Q: Did anything in LinkedIn’s S-1 jump out at you? Were you surprised its revenue isn’t greater than it is?

A: LinkedIn isn’t Facebook in that department, but its revenue is growing. More, it has a powerful name and 90 million users. That’s hefty. Plus, the influx of capital will enable them to bring on potential acquisitions and add to their highly proprietary product.

Q: But with a liquid secondary market along with very supportive investors, I gather LinkedIn could have done more acquisitions as a private company, too. You don’t think, as do some people, that LinkedIn should stay private longer?

A: No, because on the secondary market, the market caps of some of these companies are getting completely out of whack. It’s too frothy. It’s almost like a blind pool. And I think the SEC will stop it.

Q: Why? These are accredited investors.

A: There’s too little transparency and [there is] froth. I’ve seen some of [the research available on privately traded companies] and it’s been poorly written and dangerous.

Q: I’m more worried about what happens after LinkedIn’s IPO. Based on historical trends, how soon afterward do you think we’ll see some seriously crappy deals get through?

A: Right now, there are basically three main criteria. You must have year-over-year increasing revenues, decreasing losses, and low to no debt. This is especially true in tech. And those companies that meet the criteria have a good shot, especially if they’re VC-backed. I’ve made it elementary, but it’s really that simple.

Q: I didn’t hear a number. A couple of years ago, the bar was at least $100 million in annual revenue.

A: Oh, no. Not now. You need a market cap of $100 million. Any company with less than that would be underwritten by a third-tier firm — a Morgan Stanley wouldn’t touch it. But revenue? No. I definitely see revenue well below $100 million, and those companies do very well, by the way.