VC-Backed Secondaries On the Rise Again –

NEWARK, N.J. – Venture-backed secondary public offerings picked up again last year with 99 issues, up from a low of 66 in 1998, according to Venture Economics. That number inched closer to the 101 held in 1997, but was no where near this decade’s record of 142 in 1995.

Last year also saw 33 “double-dippers” – companies that had both an initial public offering and a secondary the same year – illustrating the pace at which venture-backed companies are burning through cash. Venture-backed secondaries are common because VCs tend to invest in fast growing companies that are hungry for capital to acquire equipment, real estate and staff.

Despite the fast pace of Internet deals, it is the capital needed for growth, rather than the time it takes to complete a deal that leads a company to a secondary. Internet specific companies accounted for only 14 of last year’s 99 secondaries, with computer software and services and other product companies holding 21 each, followed by communications companies with 17.

Menlo Park-based Kleiner Perkins Caufield & Byers backed 92907 Rhythm NetConnections Inc., a high-speed digital data communications company in Englewood, Calif., held an IPO and a secondary last year. “I see a lot of two-step IPOs – a company goes public and within a year follow on with a secondary,” said Kevin Compton, a general partner at Kleiner Perkins. “The company needs a lot of capital to build a telecommunications network.”

Rhythm NetConnections, like other telecommunications companies, needs a constant cash flow to buy telecommunications infrastructure equipment, routers and collocation space, as its business continues to grow. Companies, especially those in the fast paced information technology world, hold secondary offerings because they sell a limited number of shares during their initial IPO to retain more of the profit on high first-day returns, said Harvard Business School Professor Paul Gompers. The strategy is to raise a portion of the capital through an IPO and then later issue more shares at higher valuations six, nine, 12 months down the road, he said.

The potential downside to holding a secondary offering is the risk that the stock price does not stay high for the period of time between a company’s IPO and when it is ready to hold a secondary, Gompers said.

An additional offering benefits investors too because it gives them a chance to buy more shares than they were able to secure during the IPO and it also gives investors a chance to see how the stock has faired in the public market, Compton said.

Not surprisingly, there is no predictable pattern to the venture-backed secondary market. Issues hit a decade high of 142 in 1995, followed by 135 in 1996. In 1997, analysts predicted the start to an upward trend in the number of secondaries after the Securities and Exchange Commission voted to shorten the period of time investors would be required to hold privately offered securities before reselling them to the public, an expectation that never came to fruition.