Is Going Public Worth the Cost? –

In the boom years, going IPO was a badge of honor. Every startup owner dreamed of introducing an idea that caught fire, taking the company public, cashing in and retiring-ideally all before the age of 30. Now that reality has set in, IPOs have lost some of their cachet.

The Sarbanes-Oxley Act of 2002 and other regulations have made an already complicated process more forbidding. As a result, mergers and acquisitions are looking like a better strategy to many small companies-and to the established companies that might buy them.

The visible swing toward M&A began last year. Venture-backed M&A valuations nearly doubled in 2004, resulting in $15.1 billion returned to investors, according to Thomson Venture Economics and the National Venture Capital Association. While IPOs remained fairly popular throughout much of 2004, they’ve recently taken a nosedive. Thomson and NVCA reported that just 10 venture-backed companies went public in Q1, the smallest number in two years.

Initial Public Obstacles

“One quarter certainly does not constitute a trend,” says NVCA President Mark Heesen. “But there is evidence to suggest that the hurdles to going public have been raised from both a regulatory and a market perspective.”

What are those hurdles? First, the cost of going public can be huge. Sarbanes-Oxley preparations, accountants, lawyers-it all adds up. By some estimates, the total cost to take even a small company public can surpass $2 million.

Going public is also distracting. Instead of focusing on running the business, CEOs have to coordinate all the elements required to pull off the IPO. And everyone from the vice president to the janitor starts obsessing with stock options instead of the job at hand.

Not only have Sarbanes-Oxley and other new regulations raised the cost of going public, they’ve also made it more difficult to find qualified personnel to sit on the board. Public companies and their officers face a lot more scrutiny.

On the other side of the equation, a number of factors are making acquisitions more attractive to established companies. Large companies trimmed their budgets to survive the lean times, in many cases cutting back on R&D. Now that public markets have improved, they have cash or market currency, and they’re looking to use it to acquire new technology.

In effect, these larger companies have outsourced their R&D. But instead of outsourcing to a particular company, they’re waiting until “survival of the fittest” has singled out the winner. The startups make the investment and fight it out in the marketplace, while the big companies sit back and let evolution do its work. When a winner emerges, an established company swoops in and gobbles it up.

Not Just a Purchase

In the past, acquiring companies were mainly looking to get intellectual property and the engineers who developed it, often jettisoning the rest of the company. Established businesses now understand that it’s worthwhile to create opportunities to keep valuable employees on board after the acquisition. These days, engineering, sales, marketing, operations, and other personnel often keep their jobs when their startup is bought.

Whether a startup chooses an M&A or IPO strategy, total dollar value is likely to be much smaller than it was during the boom. Today, a successful deal is likely to fall in the range of $100 million to $250 million.

If you’re the vice president at a startup who owns 1% of the company, a couple of million dollars is a nice bonus for a few years of work, but it’s hardly enough to let you retire to your private island. Executives of acquired companies are now more likely to forgo the quick exit and help the new company make the most of its acquisition.

Wes Raffel is a General Partner at Advanced Technology Ventures. He focuses on communications and Internet infrastructure and sits on the boards of CaseCentral, Omneon Video Networks, Packet Design, Precision I/O, Redline Networks and Rfco. He may be reached at