With a massive backlog of portfolio companies about to go public, venture capitalists may be giving thanks for more than turkey and cranberry this month.
Pending IPOs could deliver one of the biggest early holiday bonuses since the dot-com boom.
After a dull summer—in which the credit crunch and the usual seasonal slowdown combined to bring the new issues market to a near-standstill—offerings are back on track. October provided a preview of the recovery, with offerings from venture-backed companies such as Compellent Technologies, a storage networking provider, and Constant Contact, a developer of Web-based marketing software, both posting gains of more than 70% in first-day trading. The forecast, market observers say, calls for more blockbusters ahead.
“There are a lot of companies that are now starting to be fast-tracked because of the far warmer IPO market and far more stable market,” says Scott Sweet, managing director of research firm IPO Boutique. He predicts the volume of new offerings will continue at an accelerated rate through Thanksgiving, drop off briefly and then pick up again in December.
That’s great news to venture funds like Onset Ventures. The last time one of its portfolio companies went public was December 2002. It now has one company in registration—EnteroMedics, a developer of implantable systems to treat gastrointestinal disorders. “The market has opened up,” says Terry Opdendyk, an Onset general partner.
Ten venture funds each have at least two portfolio companies in registration (see table). JPMorgan Partners leads the pack with four, followed by Intel Capital and Canaan Partners with three each. The seven firms with two companies in registration are Austin Ventures, Institutional Venture Partners, Integral Capital Partners, MPM Capital, New Enterprise Associates (NEA), OrbiMed Advisors and Rho Ventures.
The market has opened up.”
It’s too early to say which firms stand to reap the biggest gains, since the vast majority of registration statements do not yet indicate how many shares the companies plan to sell or their planned offering prices. Anecdotally speaking, there are a few that look very well positioned given the sheer size of their ownership stakes. Austin Ventures, for example, owns 8.6 million shares, or 66%, of CreditCards.com, which plans to raise $115 million. And Greylock Partners owns 12.6 million shares, or 32% of talent-tracking software developer SuccessFactors, which is looking to raise $125 million in its IPO. Meanwhile, DCM and NEA own 32% and 30%, respectively, of Neutral Tandem, a telecom exchange service provider looking to raise $99 million in its IPO. Their stakes would be work $96 million and $91 million, respectively, based on the proposed price of $13 per share.
Anatomy of a backlog
VCs stand to profit handsomely should the IPO boom prediction come to pass. The accumulation of pending deals is reaching proportions comparable to the beginning of the decade. All told, 41 companies with venture backing were in registration to go public on U.S. exchanges as of Oct. 15, according to Thomson Financial (publisher of VCJ). As a group, they are looking to raise more than $3.7 billion.
Internet and technology deals are seeing the heaviest pre-offering demand, says Sweet. Expected high-flyers now in registration include SuccessFactors, storage server company 3PAR and non-profit agency software provider Convio.
But the backlog isn’t confined to venture-backed companies. According to data tracker Dealogic, the estimated value of all pending IPOs stands at around $28 billion, the highest level since 2000. In general, venture-funded companies have been comparative latecomers to the surge in new offering registrations, says Jeff Becker, managing director and co-head of the software banking group at JMP Securities.
“VCs took a little bit longer to convince that the IPO window was open than the public buy-side investors,” Becker says. But now that they’ve been persuaded, he adds, venture capitalists are taking an increasingly active role in getting portfolio companies prepped for market.
VCs took a little bit longer to convince that the IPO window was open than the public buy-side investors.
Talk is rife in investment banking circles about who will be next. Becker points to MySQL, the-fast-growing developer of open-source database servers, as a likely IPO candidate. The company has raised about $40 million in venture funding since 2001 from firms including Benchmark Capital, Intel Capital, Institutional Venture Partners, Index Ventures and Sweden’s Scope Capital Advisory.
Other possible public market entrants include venture-funded Gomez, a developer of Internet performance monitoring tools, and RealPage, a software platform for property managers.
Life sciences offerings are generating less excitement. ZARS Pharma, a venture-backed developer of topically applied drugs, withdrew its planned $75 million IPO in October, citing “market conditions.” Two others, Targanta Therapeutics, a developer of antibacterial agents and MAP Pharmaceuticals, a respiratory therapy company, made it to market only after slashing initial share prices below their anticipated range. “People just don’t want to tie up their money in early stage biotechs when some of the biggest biotechs like Amgen and Genentech are way off their highs,” opines Sweet.
Year of recovery
Even without the glut of IPOs in waiting, 2007 is shaping up as a far better year for public market exits than the preceding one. As of mid-October, 58 venture-backed companies had launched IPOs on U.S. exchanges, raising about $7.5 billion and generating a combined market capitalization of around $38 billion. Over the same period last year, just 39 companies went public, raising $3.7 billion and generating a market cap of $16.3 billion.
IPOs are also generating a larger share of exits, says DCM General Partner Peter Moran. He points to public market offerings this year by portfolio companies Clearwire, a WiMax provider, and HireRight, an employment screening service. “For us, the positive news has been the return of the U.S. liquidity market,” Moran said during a panel discussion at a VC conference last month. He noted that in recent years the principal exit mechanism has been M&A.
The IPO market is better now than a year ago, but it’s a very cyclical market. Sure we’d like to see big IPOs from our GPs, but that’s not the primary [exit] mechanism.”
Becker says it is unlikely that the technology companies in registration will withdraw their offerings. The unwinding credit crisis in the financial services industry should have little effect, he says, since tech companies tend to have little or no debt. Aftermarket performance of those that have debuted this year has also been strong overall, which bodes well for newcomers.
In contrast to the last IPO bull market, public market investors are exhibiting more discriminating tastes in new technology offerings. While unprofitable companies are still able to launch successful offerings, investors are demanding they meet other metrics, says Sweet, including double-digit revenue growth, decreasing losses and annual sales at least in the tens of millions of dollars.
Even those companies that make the cut are waiting longer to get to market. The combination of Sarbanes Oxley compliance burdens and a longer wait for securities officials to approve new filings has added about a month to the wait-time from registration to IPO, Becker says. That means a typical IPO will take four months, compared to three a few years ago.
For now, limited partners expect M&A will continue to be the main source of venture returns, says Pawan Chaturvedi, a partner at Altius Associates, which manages private equity portfolios for institutional clients. LPs who’ve bet on a resilient IPO market in the past, he notes, have since learned to rein in such bullish expectations.
“The IPO market is better now than a year ago, but it’s a very cyclical market,” he says. “Sure we’d like to see big IPOs from our GPs, but that’s not the primary [exit] mechanism.”