Diverse Investor Group Backs New IPO Procedure –

SAN FRANCISCO – Bill Hambrecht, a pioneer in the venture capital industry since co-founding the investment bank Hambrecht & Quist in 1968, knows the value of strategic partnerships when introducing radical new concepts.

After all, Hambrecht & Quist made its name by ushering venture-backed companies through initial public offerings, mergers and acquisitions and other exit strategies. The investment bank’s most successful deals always have had the most talented VC backers who could offer expert advice as well as capital to their portfolio companies.

Increasingly, however, start-ups are at no loss for capital. The trick today is to pick capital sources wisely – investors who can provide bang along with their bucks. W.R. Hambrecht + Co., Mr. Hambrecht’s year-old investment bank with a revolutionary new method for pricing IPOs, aimed for just that when it closed its first round of institutional financing in early June, reaping $50 million from a bevy of strategic investors. Among them were network technology developer Novell Inc.; Fidelity Ventures, the private equity arm of mutual fund company Fidelity Investments; mutual fund company American Century Investments; Instinet Corp., the electronic brokering division of international news service Reuters Ltd.; and epartners, News Corp.’s venture unit.

Bootstrapped with $10 million from Mr. Hambrecht, the fledgling online investment bank initially targeted $15 million for its first round of institutional financing. However, the firm soon realized investor interest far outweighed its target, and some high-quality investors had to be turned down, says Ian Zwicker, president of W.R. Hambrecht.

“We didn’t want to just get money, we wanted strategic relationships that could help us down the road,” he says, noting that the capital will be used to double W.R. Hambrecht’s 50-person staff by the end of the year and open additional branch offices in New York, Boston, Seattle, Europe and Asia. The bank also will use part of the financing to bankroll VC investments of its own, with each deal averaging between $500,000 to $1 million.

Mr. Zwicker concedes that W.R. Hambrecht’s roster of investors may appear eclectic at first glance, but each partner provides a distinct area of expertise that will help the firm break new ground in the online financial services industry.

Fidelity and American Century provide financial expertise and understand the needs of an individual, Instinet and epartners offer advice on how new media opportunities can enhance W.R. Hambrecht’s online services, and Novell keeps the bank on the cutting edge of new technologies.

“We invest in technology companies that share Novell’s strategy,” says Novell Ventures Director Blake Modersitzki. “It made sense to partner with a company that helps people do business over the Internet.”

W.R. Hambrecht’s goal is to overhaul the traditional method for taking companies public by removing the arbitrary allocation practices used by investment banks while also providing equal opportunities for smaller investors, and even individuals, to get in on the best deals. “We can revolutionize the way new issues and secondaries are priced,” Mr. Zwicker says.

Under the firm’s OpenIPO system, potential buyers of a new issue participate in a “Dutch auction”: bidders submit the number of shares they want to buy and the price they would be willing to pay for those shares. When the auction is complete, the highest bidders are awarded all the shares they requested at the lowest accepted bid price. Buyers who submitted the lowest accepted bid receive a proportionate amount of the remaining shares.

The idea behind the system is that stock will end up in the hands of the buyers who want it most – investors that have the company’s best interests in mind and who are most likely to become long-term investors. Open IPO is designed to counter nepotistic investment banking practices such as “spinning,” in which good customers of banks receive access to the best IPOs in exchange for more business. Spinning is harmful to young companies because their shares are sold to large institutional investors that often immediately sell the stock for a quick profit, diluting the offering in the process, Mr. Zwicker explains.

Traditional investment banks also routinely underprice IPO stock so that shares quickly make huge gains in the public market. This practice hurts companies, as millions of dollars are lost when the stock soars after investors express heavy interest in the undervalued stock. With OpenIPO, the stock opens trading at a price that is representative of the public’s interest, providing both the company and the stock buyer with a fair price.

Of course, OpenIPO is very new idea, and the investment banking community has voiced its fair share of criticism, particularly after W.R. Hambrecht’s second deal – Salon.com’s ho-hum June IPO. The Web-based magazine’s stock opened at $10.50, but instead of enjoying the wild success of other recent Internet IPOs like Priceline.com or InfoSpace.com, it slipped to $10 by the end of its first day.

Critics were quick to blame Salon’s uninspiring performance on the Dutch auction process, which pushed the stock’s opening price slightly higher than it would have been otherwise, thus making investors cautious. Advocates suggest that investors must become more comfortable with the OpenIPO concept before it can really take off. However, Salon.com’s thud in the public market can also simply be attributed to a lack of excitement about the company’s business model, which predominantly relies on advertising revenue rather than the ever-popular e-commerce space.

“I don’t expect our competitors to say [OpenIPO] is the best idea since sliced bread,” Mr. Zwicker says. “This is a disruptive idea.”

W.R. Hambrecht’s investors, however, did not seem alarmed by Salon’s offering. “We think [OpenIPO] is a better mousetrap,” says American Century Senior Vice President Harold Bradley. W.R. Hambrecht’s online investment banking rival, Wit Capital, was no more than “cosmetic surgery on an old body,” he adds. “It’s the electronic arm of a traditional investment bank.”

Novell’s Mr. Modersitzki agrees, adding that he sees huge potential in W.R. Hambrecht’s niche. Even his parents in Idaho, not the prototypical Internet geeks, now conduct financial transactions online, he says.

“I think the OpenIPO area is a very sound and attractive opportunity,” he says. “As people become more comfortable making transactions … it will become just a part of life.”

Correction: An article in the July VCJ Deals in Brief section omitted TL Ventures as one of the lead investors with Oak Investment Partners in a $20 million round of financing for Esperion Therapeutics Inc. The remainder came from Stockholm-based HealthCap AB. Scheer & Co., which helped found Esperion, did not participate in the round. Industrifonden of Stockholm provided a $6.2 million project loan. Esperion, which develops a treatment to unclog arteries using apolipoprotein A-I Milano, has raised $15.5 million to date.