It’s Open

This year should be a good year for venture-backed technology IPOs, even if Facebook, Groupon, Zynga Game Network and Twitter don’t decide to go public.

That may sound like an odd thing to say since these darlings of the social Web are stoking the current round of Internet fever with hopes of sky-high IPOs and Internet dreams of a Netscape-like excitement for everything online.

But the venture industry probably won’t see such high drama unfold with their exits. A new IPO cycle has been building since last summer. But it is lesser-known tech startups setting the tempo. And it may stay that way for much of the year and perhaps early 2012.

“There have never been as many private technology companies of scale, with profits, and good growth prospects,” says J. Sanford Miller, general partner at Institutional Venture Partners and co-founder of the investment bank Thomas Weisel Partners. “You’ve got an unprecedented supply of attractive companies.”

This steady supply could offer the industry’s its best run of exits in nearly a decade and bring a welcome dose of prosperity.

What’s more, after years of flagging fund returns, a healthy, but not overheated, market could whittle down the enormous backlog of portfolio companies. It also could drum up new LP enthusiasm and help reverse declining fundraising.

But breaths are aleady being held. The first quarter of 2011 saw a respectable 14 venture-backed IPOs, a 56% improvement from the same quarter a year earlier and the strongest opening quarter for a year since 2007, according to the National Venture Capital Association (NVCA) and Thomson Reuters (publisher of VCJ).

But the pace will need to accelerate if IPOs are to top the 94 launched in 2004, the peak year during the new millennium, and set a new post dot-com high-water mark. There are signs activity is picking up. As of mid-April, about 50 U.S. VC-backed companies were filed with the Securities and Exchange Commission to go public. But the market has a lot of ground to cover.

Solid 2011

It’s easy to see why 2011 is shaping up as a solid year for IPOs. Startups have had extra years to grow and strengthen. The median age of a venture-backed IPO company is now 10 years compared with less than five in 1999, and many of the companies coming to the market now have substantial revenue and customer accounts.

Companies are having good post-IPO track records. At the end of last year, the average 2010 technology IPO stock was up 42% from its offering price. As of late March, 11 of this year’s 14 IPOs were trading at or above their offering prices.

With investor confidence on the rise, “the public market window has finally gotten over the 2008 and 2009 malaise,” says Steve Eskenazi, an angel investor and former managing general partner at Walden Venture Capital. “The next 12 to 24 months should be great.”

There are many examples to support such a claim. Cornerstone OnDemand Inc., a 12-year-old startup with 480 clients and a reported $46.6 million in gross revenue last year, saw its shares jump $46.7% on its opening day in March. Before going public, Cornerstone raised about $41 million from such firms as Bessemer Venture Partners, Meritech Capital and Bay Partners, according to Thomson Reuters.

“It tells you there is an appetite for these companies,” says Jeff Richards, a partner at GGV Capital.

Chinese stocks are contributing to the market’s enthusiasm. Qihoo 360 Technology shot ahead 134% on its opening day and the browser-and-security company continued to trade high, despite posting only $8.4 million in profit last year.

More feeding frenzies are expected. LinkedIn, which has a bigger name than most of this year’s IPO candidates, is almost certain to do well on its first day. The social networking site (which still had not set a date for its IPO, as of VCJ’s deadline in late April) has 90 million members and posted $243.1 million in revenue last year, up 102 percent. Profit came to $15 million. The only drawback to the offering appears to be its dual-stock system.

Popular Internet music service Pandora Media Inc., which boasts 80 million listeners, $55.2 million in revenue last year and fiscal 2010 losses of $16.8 million, also should find a welcome reception when it launches. This is despite its decision to use more than $27 million of its offering proceeds to pay accrued and unpaid dividends to preferred shareholders.

Pandora raised about $65 million from investors, including Crosslink Capital, Greylock Partners and Walden Venture Capital according to Thomson Reuters.

Another hot IPO is HomeAway Inc., the Austin, Texas-based, 7-year-old online market place for vacation rentals, which wants to raise $230 million. Reported revenue in 2010 came to $168 million, up 39.6%, and the company posted a net profit of $16.9 million, before accumulated dividends and preferred stock discount accretion.

The company raised $756 million from Austin Ventures, Redpoint Ventures, Technology Crossover Ventures and Institutional Venture Partners and others, according to Thomson Reuters.

Also worth watching is Kayak Software Corp., which in March updated its IPO prospectus to show 52% sales growth in 2010. The company was founded seven years ago and had $170.7 million in revenue last year. Its investors include Sequoia Capital, Accel Partners, Oak Investment Partners and General Catalyst Partners.

Likewise, Fusion-io Inc. is expected to see strong interest in its offering. The 6-year-old Salt Lake City-based solid-state hard-drive company serves a hot market with clients such as Facebook, IBM and Hewlett-Packard. In the last six months of 2010, revenue came to $58 million and the company had a net loss of $8 million. The company raised $115 million in venture funding from New Enterprise Associates, Lightspeed Venture Partners and Accel Partners, according to Thomson Reuters.

Why companies such as Kayak and Fusion-io, which are far from household names, are defining the market is easy to understand: Facebook, Zynga, Twitter and Groupon don’t need to go public. They don’t need the visibility an IPO brings, and they don’t need the liquidity.

Founders of Facebook, Zynga, Twitter ad Groupon can sell shares in the secondary market. They also have access to private capital at favorable rates, if they need it.

Instead, their IPOs will likely be triggered by the 500-investor threshold, which the SEC is reviewing and could possibly modify. Companies that cross the threshold are forced to disclose financial information, and many choose to go public in the process. Early this year, Facebook said in confidential documents sent to investors that it anticipated crossing the threshold this year, implying an early 2012 offering is under consideration. If the threshold changes, the timing could, too.

Zynga, according to the New York Times, also won’t consider floating stock until next year. And while speculation emerged recently that Groupon is in discussions with Goldman Sachs bankers for an IPO anticipated this spring, the company raised $950 million in January. So it isn’t in a hurry to raise money.


Even if these big names remain on the sidelines, the IPOs currently underway could have an impact on the industry’s health. That’s because fund returns have been held back by the large backlog of portfolio companies yet to generate liquidity.

John Taylor, vice president of research at the NVCA, calculates about one-third of the value of active venture funds remains locked in portfolio companies that haven’t exited. For each dollar venture funds raised between 1981 and 2009, $1.08 has already been returned to LPs, he says. Another 45 cents of value is in the portfolio companies, he adds. Finding liquidity for these companies would have a quick impact on returns.

From 2000 to 2009, the industry provided first time funding to an average of 1,279 companies a year, yet only an average of 5%, or 67, went public each year.

“We haven’t been at 14% for a while,” Taylor says.

Still venture firms are paying close attention to the improving market. Globespan Capital Partners—an investor in Zipcar, which went public in April—has one more portfolio company in registration: Glasshouse Technologies.

Another four to six companies could be ready to file within four to eight quarters, says Dave Fachetti, managing director of Globespan. They are profitable and growing at a 50% pace or greater, he says.

Clearly “we’re going to have a very strong 2011 for IPOs,” says Neeraj Agrawal, a general partner at Battery Ventures, and “I predict we’re going to have a pretty strong first half of 2012,” too.

Agrawal says that Battery has nine portfolio companies likely to IPO in the next 15 months, some of which have $100 million or more in annual revenue that many observers see as the ideal benchmark for candidates.

The IPO frenzy appears to be spilling over into cleantech.

“You’ll see some interesting companies filing over the course of the next few months,” says Alan Salzman, CEO of VantagePoint Venture Partners. “We are going to see a couple of bellwether companies go.”

The challenge for cleantech is that companies are generally younger and less mature, so an IPO for many in the sector is considered a stretch. By some estimates, only 100 or so cleantech startups in the United States are six years or older. Nevertheless, 2011 could see leaders in thin film solar, LED lighting and smart grid take the plunge, Salzman says.

“I feel we’re coming into a period that reminds me of the mid-1990s,” says Miller of IVP. “There is significant investor appetite for IPOs.”

There also appears to be some possibility of a bubble, especially if a Facebook or Zynga files.

Until then, what’s clear is that the industry is facing an opportunity is hasn’t seen in a number of years and one it badly needs.

Investors, Entrepreneurs See Opportunities, Too

Venture capitalists aren’t the only ones salivating over the return of the IPO market. So, too, are entrepreneurs and public market investors.

“This [IPO] window is something I think about every day,” says Ben Smith IV, chairman and co-founder of MerchantCircle, an online marketing service for small companies. “You don’t want to be left behind.”

Smith declined comment on whether MerchantCircle—which has raised funding from Rustic Canyon Partners, Scale Venture Partners and Steamboat Ventures—has plans to go public. But for an entrepreneur, “it’s an incredible time to be a critical mass company,” he says.

As a result, the activity level is high. Observers say that there are a lot of companies conducting pre-public listing audits and considering M&A activity to rollup startups into organizations large enough to sell shares to the public.

So far, motives appear to be good. An IPO can be a useful financial tool for a company rather than simply a liquidity option for its executives, and entrepreneurs appear focused on long-term capital needs rather than quick deals.

“Entrepreneurs are very excited about what they’ve created” and want to continue to make it grow, says Dave Fachetti, managing director at Globespan Capital Partners.

Much like the entrepreneurs, investors have noticed the changing IPO market and are paying attention.

“Institutional investors, both small and mid cap, are definitely looking for visible, organic growth…but they want to understand the deals,” says John Moriarty, managing director at investment bank Robert Baird & Co. The market is not yet frothy, he says.

Evidence of selectiveness is apparent in the number of companies that haven’t been willing to sell shares even after filing S-1s. Skype Ltd., for instance, filed to go public in August 2010, but now looks to have postponed the launch of its shares until at least the second half of 2011. Force 10 Networks, the 10 gigabit Ethernet company, filed in March 2010 but still hasn’t floated its shares, and the online electronics retailer Newegg is in a similar offering netherworld.

“Investors aren’t buying all IPOs,” says Lise Buyer, founder of Class V Group, a company that advises startups preparing IPOs. They want ones with sound financials and real markets.

They also haven’t warmed up to smaller IPOs. Smaller companies that routinely would go public in the 1980s and 1990s aren’t yet making the cut this year. If a firm has $20 million or even $35 million in sales, it doesn’t stand a strong likelihood of attracting investor attention, even if it has been profitable for two or three quarters, experts say.

“I think we’re starting to see the emergence of some real companies and real businesses that will get investors really excited,” says veteran investment manager Jeff Matthews. “It is going to be very powerful.”

VC Perspective

China’s Mighty IPO Engine

By Jeff Richards

Partner, GGV Capital

There is an impressive IPO engine building in China with high profile companies launching on U.S. exchanges to thunderous applause and high valuations.

Baidu and Youku are two good examples.

On the home front, one result of China’s IPOs is greater domestic growth, including job creation and innovation.

From the United States perspective there is a spillover of wealth creation. Four of the 10 top performing IPOs in the United States in 2010 were the Chinese companies JinkoSolar, Camelot Information Systems, hiSoft Technology International and Youku.

In total, 41 Chinese companies completed IPOs on U.S. exchanges in 2010, trading up an average of 13% through the end of the year. Should these companies continue to perform well, and their stock prices hold or rise, we expect to see the pace of Chinese offerings continue in 2011. A healthy number of Chinese companies are in registration on U.S. exchanges, and Internet security company Qihoo 360 Technology recently debuted with a 134% rise on its first day of trading.

Beyond these headlines, however, there is a story that has not been given enough attention. A total of 435 Chinese companies held IPOs last year across the Hong Kong, China Main Board and China Shenzhen Board exchanges.

Many of these companies raised less than $50 million, a threshold for offerings we haven’t seen in the United States for many years. The average U.S. tech IPO in 2010 raised $105 million. (Historical note: At one time, sub-$50 million IPOs were common in the U.S. Intel, for instance, raised just $6.8 million with its 1968 offering, an inflation-adjusted $42 million today.)

Along with the relatively low capitalization threshold, it also is worth mentioning that most Chinese IPOs aren’t venture-backed companies. Only about 150 last year were. Nor are they private equity-backed, “return to market” deals.

In many cases, they are companies run by entrepreneurs who have self-financed the growth of their businesses and operated them profitably for years. They are leaders in agriculture, manufacturing, biotech, consumer products and other industry segments that are riding the economic growth wave in China.

Any rising trend has its counterbalancing challenges. Chinese IPO investors often complain of low levels of liquidity, high multiples and varying regulations in China.

However, the Chinese IPOs phenomenon appears poised to continue in 2011 and investors around the world are taking notice.

They and China will likely continue reaping the benefits.

Disclosure: GGV Capital is an investor in hiSoft, and six of its portfolio companies completed IPOs in 2010 across four different exchanges: Nasdaq, NYSE, Hong Kong and Shanghai.

Executive Perspective

IPO Challenges Require Advanced Planning

By Anthony McCusker

Partner, Goodwin Procter LLP

During the recent financial crisis, few U.S. venture-backed companies undertook IPOs. As the market for IPOs has improved, several of the most prominent venture backed companies are electing to remain private.

Some pundits and politicians, including Rep. Darrell Issa (R-CA) in his much commented upon letter to SEC Chairman Mary Schapiro, blame U.S. regulations for reducing the desire to go public. However, managers contemplating IPOs confront a diverse set of challenges—not all regulatory—as their companies cross from private to public.

A company contemplating an IPO should begin to prepare at least nine to 12 months before it officially kicks off its offering process. This preparation time is necessary to have a properly constituted public company board of directors and to ensure appropriate controls and procedures are in place to satisfy public company reporting requirements. These efforts are in addition to things typically associated with IPO preparation, like banker selection and S-1 preparation.

A typical VC-backed company will have to add to, or reconstitute, its board of directors, and establish or reconstitute board committees, to satisfy board “independence” requirements. Adding new, independent board members on the eve of an IPO is extremely difficult as a new director will likely want to observe the company’s management, board and forecasting ability over at least one or two quarters to gain confidence. In addition, while these “independent” directors usually add terrific experience, their addition may change board dynamics.

These changes often mean the CEOs and CFOs are required to spend more time on the “care and feeding” of the company’s board to ensure it operates effectively.

A company contemplating an IPO will be required as well to establish new systems and controls, purchase accounting reporting software and hire financial staff to comply with Section 404 of Sarbanes-Oxley. Section 404, often a “poster child” for critics, requires public companies to have in place appropriate internal controls for assuring the accuracy of the company’s financial reporting and disclosures. It also requires management and the company’s auditor to certify the adequacy of the company’s controls. The management time and real dollar cost associated with preparing for 404-compliance is material.

Private companies enjoy the ability to keep confidential their most sensitive information, but post IPO rules require the disclosure of an array of information, including terms of customer and supplier agreements, executive compensation and performance targets for senior employees. Many executives express concern these disclosures will curtail their ability to communicate with employees as transparently as they had pre IPO and make it difficult to preserve their corporate culture.

As a result, management and board members must strive to maintain the innovative culture that made their company a desirable place to work while satisfying the demands of public company compliance and learning to live with the new focus on street expectations.

While these challenges confront companies contemplating an IPO, they are not prohibitive if managed properly and planned for in advance. For most companies, the numerous benefits of an IPO, including a significant fundraising event, greatly outweigh the work involved.

VC-Backed Companies Currently in Registration

Advanced BioHealing Inc.

Ambit Biosciences Corp.

Apache Design Solutions Inc.

BioHorizons Implant Systems Inc.

BrightSource Energy Inc.

Broadview Networks Holdings Inc.

Clarus Therapeutics Inc.

Cortina Systems Inc.

Ellie Mae Inc.

Fallbrook Technologies Inc.

Force10 Networks Inc.

Fusion-io Inc.

GlassHouse Technologies Inc.

HomeAway Inc.

Horizon Therapeutics Inc.

Inrix Inc.

InvenSense Inc.

IronPlanet Inc.

Kayak Software Corp.

Kosmos Energy, LLC

LinkedIn Corp.

Newegg Inc.

Newgistics Inc.

NewLink Genetics Corp.

NEXX Systems Inc.

Pandora Media Inc.

Peregrine Semiconductor Corp.

Prometheus Laboratories Inc.

Quark Pharmaceuticals Inc.

Reply Inc.

Responsys Inc.

Solazyme Inc.

Suniva Inc.

Tangoe Inc.

The Active Network Inc.

Tripwire Inc.

Trulia Inc.

Source: NVCA and Thomson Reuters