maybe it won't happen the way you imagine it will Fred, You and I know that VC is rarely required today to do anything substantial. The internets are evolving, yes internets, and they are evolving faster than investors can understand, big businesses are shrinking fast and size today is usually a competitive disadvantage. The next big things will probably not involve hundreds of people in a monster organization. They will be rapid and revolutionary but won't have the baggage of size that today's FB, Google, Yahoo and MS have. They might go IPO, because the markets will still be greedy but they won't need to go IPO. What will be different this time is they won't need or want external capital and the really smart entrepreneurs will avoid external capital. The new entrepreneurs already have all the useful capital that they need. It's the intellectual capital in their heads and their spirits. Anyone needing to raise a bunch of money probably doesn't have a great idea and we all know that VC's are part and parcel of the entitlement society, They are not stewards of innovation. They are just a different type of speculator. The new entrepreneurs will develop and trade in ideas and communities. “Intellectual property", Bill Gates once said, "has the shelf life of a banana”. Without constant innovation you won't survive. The greedy and lazy VC's will probably compete for the crookedest enterprises available and the Smartest VC's will probably become social entrepreneurs. "A business that makes nothing but money is a poor business. " -- Henry Ford
fredwilson
· 7 months ago
i agree with much of what you say, but my experience is that once a web service gets scale, you need serious capital and VC is typically where entrepreneurs turn. i posted my thoughts on that a few years ago.
scale Fred? Are you sure about scale? That's the big assumption that you are basing your strategy on? What if there's no scale required? These are technology businesses, not low tech manufacturing factories. With technology you can always assume that the revolutionary thing will be the technologies developed and deployed. The only constant that matters is [xyz], The competitve advantage is [abc]. I'll let you fill in the xyz and abc. I know of a project that someone is working on that does not need scale but is revolutionary enough to completely obsolete entire categories, even sectors of the economy. Naturally like yourself I can't disclose much, but i would recommend that you rethink your strategy and find some social enterprise opportunities to invest in. I don't expect that you will be able to get off of the "make a killing" mentality but that's your clue from me. Like i said earlier, Smartest VC's will probably become social entrepreneurs.
Mihai
· 7 months ago
It seems to me that currently to scale you need money. You'll always need money for tech businesses. For several reasons:
- engineering. It's never one idea that's enough. You need constant innovation, and for that you need to create at least a small environment of people with slightly different backgrounds. Most ideas are replicable with the same or different technology. Take page rank for example. It's easy to replicate and there are different technologies that do the same. In fact, Jon Kleinberg's work predates Google (also note it did not appear in STOC/FOCS, but rather SODA and lower tiered conferences -- you may wonder why). Therefore, just for quality (in this case websearch) you need to constantly innovate.
- PM: users are changing. Innovation goes beyond eng, and again, you need lots of talent to keep on top of the users. Just show me a tech company that fully understands its users.
- sales: if you need sales, you'll most likely need size to scale.
- ops, infrastructure, marketing, legal, etc.
I'd love to buy into the idea that a start-up wont need size to scale fast. I'd love to buy into Ruby on Rails and other platforms. I agree that all this technology will make it easier for start-ups, but in a winner takes all environment, the lack of funds is poison.
fredwilson
· 7 months ago
i've said this in other parts of this comment system, but services that are social and scale require large investments in "environmental remediation and governance"
kidmercury
· 7 months ago
IMHO that is because the web services we've seen up until now have required scale before they can get to profitability/exit. i think we will start to see models where profitability is attained early on, and those profits can be reinvested to fuel additional growth. also i think as online communities develop, grassroots/microfinance options will become available and in many ways easier and more cost-effective for all.
Joseph Lizio
· 7 months ago
I have to agree - regardless of how cheap and easy it is to start a business these days - it does require some outside push to really take it to that perfect level. Usually as a company starts to realize significant revenue - it just goes right out the door as it cannot keep up with development or innovation or even the founders sucking out the cash.
Althought I do like the idea of having many different companies doing what one big company does today - e.g. I rather have 20 different Fords then just one really big Ford.
Regarding the IPO market - two thoughts - Do you really see signs or are you just hopeful? If the window does open, will there be a mad dash and will the first ones there (not necessarily the best one) get the cash?
fredwilson
· 7 months ago
There are signs: changeyou and rosetta stone and hopefully open table. Being first is not always best so I don't think we'll see a rush
ewiesen
· 7 months ago
The claim here is the future of business is essentially iPhone apps. Small teams building to early but small profitability. I agree with Fred - real businesses of significance require scale. If the venture business is "relegated" to funding those businesses (as opposed to the $4-8M takeouts), that's fine and good.
tweetfeeds
· 7 months ago
in your world real businesses of significance require scale. ...it has nothing to do with iphone or mobile, keep guessing Eric, every revolution brings different economies of scale. Is there a future for VC's, probably but the power has shifted to the innovators, so most traditional VC's will be chasing their tails looking for the next MS, GOOG, etc. while the real revolution unfolds. Have you ever wondered why when you point a finger at a dog, it looks at the finger and when you point a finger at a child they look at where you are pointing? That's your hint Eric. What Henry Ford said so long ago is still true today. "A business that makes nothing but money is a poor business. " -- Henry Ford
Mihai
· 7 months ago
I have 3 friends who built a very serious iPhone app. Just a few days after it launched, it only sold a few times, but the backend traffic was more than 100 times higher. That means 99%+ of the apps were pirated. Apple wouldn't comment and pointed to an old bug report for a duplicated issue, which is not viewable due to lack of permissions. Apple's strategy seems to be to make money out of contracts, not out of apps. It sees apps as a customer attraction: cute, but not milk-able. (which makes sense since the vast majority of apps are amatorish)
Until we see more commitment for the apps, this sector will not develop. Maybe a platform to show adds, or in-house protection for apps with backends. The time for a quick buck from the Apple store seems to be over.
Android to the rescue!
Leonid S. Knyshov
· 7 months ago
Let's hope you are right.
We need to restart the virtuous cycle. Positive articles will probably bring a positive effect along with them. :)
aweissman
· 7 months ago
I think Facebook goes public and is a (*the*) catalyst for this
Kieran O'Neill
· 7 months ago
Interesting article Fred, thanks for sharing.
Andy - agree, will definitely be interesting to see the affect Facebook and LinkedIN IPOs have on the marketing :-)
Kieran O'Neill
· 7 months ago
Er, "have on the market" rather.
(Surprised Disqus doesn't have edit for Facebook Connect comments)
tetsuotrees
· 7 months ago
@Fred - great post and a very interesting take. RE: cost of Sarbox compliance, the last time I was involved in this sort of thing our estimated "Sarbox nut" was around $1.5mm (itself down from as much as $3mm in the beginning) - has this number come down appreciably in your experience, or does it still remain at about that level? (amount is 404 compliance only, not including audit fees...)
fredwilson
· 7 months ago
i will ask around. and hopefully someone will reply to this who has new information on these costs.
JLM
· 7 months ago
SOx and 404 are the biggest crocks of crap ever invented. They fail to make a crooked company honest and they cannot make an honest company "honester". They are total nonsense. Accounting practices created by politicians who brought us the GSEs and their accounting standards!
I run a public company and have dealt with this nonsense for years. I am contemplating not complying at all with 404 --- which is a glorified bunch of Visio flow charts and written explanations pertaining to "critical financial controls" culminating in an opinion from management that its "financial controls are adequate" and a review by an auditor who says the same things --- more likely "management's opinion is reasonable".
It is all one step removed from fingerpainting or paint by numbers. It is as relevant to business as a debutante party is to national defense.
If you fail to comply with 404 -- which means you do the Visio nonsense and the write ups but don't submit it to be reviewed and audited --- then you simply footnote your 10K and disclose this fact. It is very, very difficult to ascertain whether you have any real penalties and what exactly the SEC or PCAOB can do to you as long as your disclosure is adequate. I will let you know about a year from now.
Public companies which now must be "reviewed" quarterly and "audited" annually and 404-ed annually are incurring annual audit fees that are about $50K per $10MM in gross revenue with about an additonal 25% for quarterly "reviews" and about the same as the annual audit for the 404 compliance.
Having said all of the above, it is a worthwhile exercise to engage in the Visio-ing of critical financial controls but it is probably a better expenditure to buy a FIDELITY BOND and create a financial reserve for losses.
I have had one big embezzler who got me for $250K and had a fidelity bond with a $1K deductible which cost me (20 years ago) an annual premium of $900. Best financial control I ever enacted.
DorianBenkoil
· 7 months ago
One Fortune 500 treasurer I know said they figured i cost them about $25-$40 million in compliance costs in 2007.
William Mougayar
· 7 months ago
That will be a breath of fresh air. As long as multiples don't get on a frenzy ride, and we stay grounded on earth, and greed doesn't replace common sense.
fredwilson
· 7 months ago
i am thinking we'll see stocks go out at 10-12x ebitda and 15-20x earnings which should be a decent price for public market investors and my hope is these stocks will perform well for public market investors as their subscription based annuity models (and good operating leverage) will allow them to grow earnings at 20-25% per year.
William Mougayar
· 7 months ago
Agreed. I think we'll need a couple of poster childs to demonstrate this and re-build confidence. Perhaps OpenTable as mentioned here, or Twitter with revenues, or LinkedIn or other unknowns yet... But i'm praying we don't hype this again (having lived thru hype cycles).
MarkV
· 7 months ago
Single product internet or software IPOs will always be hype. Why? Because the product is essentially a feedback mechanism that evolves and morphs as the customer evolves and changes. As such, it will go through rapid development with boom and bust cycles. Software companies do not level out until they approach a significant installed base or a large number of skus.
JLM
· 7 months ago
Wow! I am unabashed capitalist and am in favor of everybody who gets up early, stays late and works hard making a SHITPOT (technical finance term) of money but the multiples you note suggest that we have learned nothing from the tech bubble.
Single "idea" tech or internet companies that came out at those multiples were unable to sustain growth rates of 20-25% for any period of time and historically saw their profit per transaction declining as the technology matured (e.g. Schwab v the traditional brokerages).
Those multiples are the multiples of seasoned, predictable, stable public companies with sound management and multiple sources of cash flow. Even then, they are aggressive. A growth rate of 15% annually for 10 years (a la GE) is a show stopper. It is the 10 years which is more important than the growth rate.
The lens through which you are viewing the marketplace seems unaltered by recent experiences. The world is not going to return to from whence we have recently come, it is going to fall down a number of parallel curves and will have to rebuild public confidence and deliver returns BEFORE there can be any movement toward those kind of multiples.
I also suspect that there is some real damage in the distribution infrastructure for IPOs with the chaos in the brokerage business.
Keep saying Dr Koop and keep thinking about Dr Poop.
I think the VC backed IPO market is going to have some real challenges not the least of which is the perceived exit strategy of the VCs --- will the public embrace them cashing in at the IPO stage? I don't think so any time soon. I do think the public will be able to understand and embrace a measured exit over a period of time.
In the new reality we are living in, a sustained 10-13% return will become a very good return for new businesses.
Steve
· 7 months ago
15 to 20 X earnings? That is highly optimistic. Much more realistic is 12 to 15x forward earnings IF the company has 3 or more quarters of operating profits AND is growing at 20 to 30% per year in a sustainable fashion.
People need to focus on profits, not revenue if you want an IPO market back. The old, tried and true metric was 3 quarters of operating profit with operating income in the double digits as a percent of revenue.
fredwilson
· 7 months ago
I agree. That's why I listed ebitda and income multiples
I think 15-20x current year is about the same as 12-15x forward if it’s a growth company
duncanjw
· 7 months ago
I agree. A viable IPO alternative to assimilation for private companies with a proven business is vital not just to the VCs and entrepreneurs involved but to investors too.
I have a follow up question - how do you see this IPO market taking shape? By that I mean will we see more dutch auctions in the future rather than the traditional IB route with its overblown and largely discredited fees structure?
fredwilson
· 7 months ago
I sure hope so. The market should set the opening price
JLM
· 7 months ago
The imprimatur of an underwriter is worth less than nothing today. They are not and have not been for a long, long time "underwriters".
Undertakers? Maybe! LOL
The disclosures which are made to be get a company public are so onerous and frightening as to have completely numbed the investing market's sensitivies. If everything can kill you, then nothing is really frightening.
If Amazon can sell books printed "just in time" directly from the publishers warehouse and in effect collect their revenue BEFORE they incur the actual expense, then it will become very, very easy to sell equity in the same manner.
There is no known substitute for competition, competitive bidding and a well run auction particulary when it can be oversubscribed and you can take only the highest bids for the appropriate number of shares.
Interestingly enough the high end auction houses have known this for years and have long ago incorporated phone and internet bids in their auction process.
The biggest problem is going to be the securities licensing issues but companies will simply have a designated person on their staffs go get appropriately licensed. A reasonably intelligent person could get the necessary licenses in about a month of study.
If one distilled the essence of the Schwab, Fed Express, Amazon, Yahoo, Costco, Sam's Club business experiences --- at the end of the day all DISTRIBUTION businesses, it is very difficult to see how a company could not get itself public in a credible auction particularly with the emerging secondary market for the public trading of seemingly private securities driving things.
And why not? Wall Street has been rigged for a considerable time and now it is time to expose the man behind the curtain!
Steve
· 7 months ago
"overblown and largely discredited fees structures" Huh? Banks don't make any money on technology related IPO's - at least those below $75MM. They used to make it up on having proprietary knowledge about trading flows, but that game is dead with decimalization.
Scott
· 7 months ago
"1) VCs have been in the penalty box for almost a decade since we committed the cardinal sin of foisting crap into the public markets. Somehow the investment bankers who helped us do it got out a lot earlier than we did. But we've done our time and others have replaced VCs as enemy number one of public market investors."
Exactly, Fred. Don't know if I already have said this, but I believe the dot com effect still hangs over the sector's shoulders (regarding IPO's). Put simply, the internet bubble was all about ideas, not about the people behind the ideas (Technical Analysis vs. Buffet Value Investing). Everyone had an idea for an internet company. You simply take an idea from the real world, and apply it to the online world. Obviously, with the “newness” of the internet, VC’s couldn’t invest in teams with a profound amount of experience in the realm. Nothing mattered except the idea. It had to be big enough to pump up, inject false hope and hopefully ride the cash-loss wave until you dished it out to the public via IPO. The best VC’s were those who could make an idea look glamorous and complete the IPO before people discovered there was no business model. Not saying you did that, when I write this, I'm thinking more along the lines of the *cough* draper fishers *cough*
Lol. Your candor is why I keep coming back almost every day.
Kurtis Fechtmeyer
· 7 months ago
There is certainly a lot of backlog in the venture portfolios. Companies are getting the hang of Sarbox and pushing back on accountant-think. The question remains: can the dysfunctional public markets, burdened by Spitzer Rules and TARP banks, deliver any valuation advantages or multiple expansion. If not, why would anyone go public beneath a $B valuation? The valuations in the public markets are still atrocious.
Kenosha_Kid
· 7 months ago
Fred, this article is particularly interesting to read in conjunction with your December 2006 "Web 2.0 is a Gift" article that you linked, which argues that despite lower startup costs, building an internet enterprise is still a $20 million commitment. A couple of questions:
1) With hindsight, would you say this is still true? Or is it now more? Less? Have different variables come into play?
2) If the VC industry has been overcapitalized (as illustrated in your articles last week), and if the rule of thumb per venture is $20 million still, does this mean that too many of these have been funded?
3) Alternatively, is it the case that much more than $20 million has gone into many of these because of high VC liquidity, the result of which being that revenue/EBITDA pressure may have been put off or eased?
I ask these questions from the perspective that some of these factors could impact the IPO market as well, in addition to the capital markets demand side you describe above. I'm guessing, because my crystal ball is foggier than most, but I would say that the M&A market would have to rebound first before the IPO market does. One, strategics could probably handle the risk profile more easily and even assign value to pre-revenue or low-EBITDA businesses. Two, public equity investors could derive some confidence from a more positive strategic M&A market.
fredwilson
· 7 months ago
Web services that scale require money for things like spam control and other forms of 'environmental remediation' and customer service
Its like managing a real commmunity
So I stand my by 'web 2 is a gift' now more than ever. I'm living it
As for IPO vs M&A, my gut tells me the IPO market will come back first for the simple reason that entrepreneurs have gotten wise to the costs of selling out to big cos
Not one of the companies I work with that is scaling rapidly wants to sell out
Mark Essel
· 7 months ago
Can most young tech companies flourish in a publicly reviewed corporate environment? Probably not but that's where you VC smart guys come in.
There's gotta be a way they can keep growing by letting the leadership navigate in the dynamic tech industry and still satisfy the public requirements. There are great advantages to staying private, but venture pushes towards liquidity events and IPO just happens to be a channel (sell the company to the public).
Market trend guessing game: I'm expecting one more drop before we get our economy aligned to steady growth. Although nothing's certain there has already been a large shakedown of multiple sections of US economy: banking/real estate/auto. How many more big sectors do we have that can get pruned down? Energy?
Will Quist
· 7 months ago
As one of the few active buyers of venture equity on the secondary market, I can tell you there is no shortage of supply of great companies, that have real revenues and a healthy profitability profile. The real issue, that Fred does highlight but most folks, NVCA included fail to address, is demand. There will be no shortage of liquidity opportunities if the companies are valued realistically based on the earnings profile (and, in the near term, probably undervaluing them slightly would not be a bad idea to stimulate demand). The capital will be there. If IPOs became liquidity events (which allows those who have helped create value realize that when appropriate for themselves) and not exits, and venture guys were willing to hold until it trades up, the issue could be priced for returns (and not profit maximization) and I think we would be well on our way towards having a public market again for venture backed companies.
That doesn't solve the issue of returns for the asset class, since many of today's great companies were financed well north of 10-12x today's EBITDA, but unfortunately I think that is part of the process of making the ecosystem healthy again...
JLM
· 7 months ago
One of the questions you imply is very, very important. It goes to the heart of the issue now and in the future.
Is an IPO a funding mechanism for the company itself or is it an exit, liquidity event for management and the original backers?
Is the company accessing cheaper capital or is it cashing folks in?
The secondary offering as a means of accessing cheap capital is a lost art form in part because of how cheap debt has been recently priced.
There was a time when going public was a huge benefit in and of itself --- it provided access to capital (both debt and equity) on a cheaper basis. I fear that now it is viewed more frequently as having no real future value but rather creating liquidity.
I don't want to buy something when really smart guys are selling the same thing.
ewiesen
· 7 months ago
Isn't it both a "liquidity event" and a fundraising event for the company? There are investors that add value at different stages of a company's life. Early-stage VCs (at least the good ones) are great at identifying, nurturing and growing young companies, but may add little value when the same company is at $250M in revenue. Different problems. The IPO is both an opportunity for the early-stage guys to get liquidity, often after 5 or more years of work, but it's also an opportunity to transition ownership to those investors who are best able to both judge and support companies at larger scale.
JLM
· 7 months ago
Of course you are absolutely correct. Such an event can serve more than one objective. The real question is: should it?
Without quibbling, it is certainly possible to make a sound argument and distinction between the relative skills of VCs in the life of a company however many would say that is simply the VC's organic challenge and that an IPO is not intended to primarily serve the purposes of the VCs but is an orderly and regulated sales process intended to protect the "new" shareholders and certainly not the sellers. The promised land is a public market and a public listing and market makers for the stock with all that that entails.
In the old days, a credible underwriter's name in the middle of the prospectus meant something. Today it means nothing. Therefore everybody has got to be held to a standard which eliminates obvious conflicts of interest.
Once the company is public and a decent interval has passed, then the VCs can exit in an orderly manner based upon the public's appetite for the stock, the volume and the pricing. Nobody would argue with that is not fair.
The argument, as you advance it, seemingly creates a sense of entitlement for the VCs --- "...5 or more years of work...". So what? If the passage of time were the only determinate factor of creating value --- then they could sell their positions to the second, third round guys.
No, you need a "public mark" to realize the value targeted.
The question continues to be are we creating liquidity events or building great companies? I don't care which it is frankly, as long as nobody pees on my leg and tells me it's raining.
If the only way out is through an IPO then everybody better make damn sure we don't create any more Dr Koops. Or be prepared to suffer the consequences.
fredwilson
· 7 months ago
i think VC lockups should be restructured. make them 2-3 year lockup agreements with something like 20% being released each 6 months from the data of the IPO. then you'd get the VCs thinking like public market investors and not sellers dying to get out
Mark Essel
· 7 months ago
Always happy to get "real data" compared to what I imagine. Buying in that secondary market could be incredible if/when IPOs come around.
I'm wondering when Fred will get wise and start his own accredited online blog university for the venture capital market. Real investors like yourself Will, make the experience of reading/commenting on Fred's blog priceless.
Since there's already a strong secondary market, validations and sharing of company information (books) must already be happening.
I think your conservative pricing approach would be a great way to get things started. As far as there being liquidity but not having VCs exit: As a public investor this would build my confidence in the offering if the people who helped make the business attractive (and hold executive positions), have a continuing vested interest.
Continually learning about asset class market limitations, there has to be a realistic value/return (correcting expectations)
fredwilson
· 7 months ago
Why can't this blog be an online unoiversity?
Mark Essel
· 7 months ago
If you're asking me, I'd say it is already ;) I'd wager students following your blog actively (commenting, reblogging) for a semester would gain AT LEAST as much information as they would in 2 MBA courses.
And they'd have better retention of the material and greater understanding as well.
fredwilson
· 7 months ago
Yes, yes, yes
Valuing these businesses reasonably and setting the proper expectations for growth and earning power is important
I also think lockups should be structured differently. Instead of letting everyone out in 180 days, we ought to break it up in fifths and let everyone free for 20pcnt every six months
Mark Essel
· 7 months ago
Is changing lockups a matter of legislation or a customized legal doc you agree upon as a VC or startup?
fredwilson
· 7 months ago
Its not a legal issue. We just need to agree as an industry and do it. Lack of leadership and creative thinking at the nvca is unfortunate
Steve
· 7 months ago
Negotiated between major shareholders and the underwriter, disclosed in the prospectus.
Austin Hill
· 7 months ago
Great post Fred,
I agree completely. One of the companies I founded in the late 90's (Zero-Knowledge Systems - who you may remember from Mike Santer's role in the company) followed the same path of many of our dot.com brethren. We raised $50+ million, grew too fast & in undisciplined ways, faced the disastrous 2001-2003 tech restructuring but unlike many at the time we survived. Since renaming itself (now Radialpoint) and after a recap to clean up the balance sheet the company it has been profitable since 2003. It now has revenues that that rival many public companies, 40% year over year growth and 40% EBIDTA profitability.
Like Stuart Ellman's comment, the company has been in a position that it could have gone public anytime in the last 3 years. Given the costs associated with being a public company and the mood of the markets we choose to do a late stage private equity deal with TA Associates in September 2008 for $98 million instead of going public. Since the beginning of 2009 we have acquired two companies that further accelerate our growth & penetration into our customer base while remaining very profitable.
I know that we are not alone as I've spoken to a number of companies that survived the dot.com crash or were founded during the 2001-2003 timeframe who have revenues around $75-$100 million and are very profitable. Like ourselves, these companies are using the current economic downturn to acquire strategic assets and will emerge as much stronger companies when the IPO drought ends.
While not all will choose to be public companies, we have hugely profitable companies with employees and shareholders (and founders) who will want a path to liquidity. When the market does recover I expect a large number of very healthy, annuity based businesses to come to market giving the industry & public markets a new confidence in technology IPO's.
fredwilson
· 7 months ago
Great comment
Great example
ronkornfeld
· 7 months ago
As you and others have noted, there is a general fail in the asset class of early stage investing. The IPO market will eventually rebound as there is a financial sector that needs inventory of new offerings. The pivotal question is whether the current early stage funding ecosystem will ever again be coupled (in a semi-predictable way) with IPO exits. The alternative is the "farm team" model where early stage companies become the petri dish of innovation and, when scientific or business progress is achieved, get acquired by the larger public entities.
fredwilson
· 7 months ago
That 'farm system' model is alive and well but I think we've become too reliant upon it
ronkornfeld
· 7 months ago
True, and it often doesn't create adequate returns. This is particularly true for the common shareholders after all of the preferences have been cleared on a smaller transaction.
cj
· 7 months ago
I believe that a *healthy* IPO market is in our future....however, I believe *later* rather than sooner.
Here's why:
We all know that economic resources are scarce.
However, it has been the policy of Bush/Obama to prop up, bailout, and inflate. In other words, forstall necessary liquidatations, keep people working in industries that should go under, and keep prices *artificially* high.
It's a battle against economic reality...and reality always *ultimately* wins.
In my view, this is not healthy soil for viable IPO's *in general*.
However, the time will arrive where it's obvious to everyone that bailouts, inflation, and silly new-new deal's can't work.
At that point the ground will be fertile for some of the most spectacular IPO's imaginable. Resources will be available, business-harming regulations will be scrapped, and entrepreneurialism (rather than lining up at the trough) will be the motivating force.
We're *obviously* not there yet.
TimWalker
· 7 months ago
From the outside looking in, Fred, it seemed to me that the financial storms of last fall -- and particularly the unfair hit that RackSpace took when it came to the market -- made lots of potential IPO debutants even more skittish than they should have been. (And they should have been wary in the first place.)
Now, though, we're finally seeing some decent companies (esp. Rosetta Stone) come to market with good financials and reasonable valuations . . . and they're not getting hammered.
Wouldn't that (mini-)trend tend to support your case here?
fredwilson
· 7 months ago
Yes, the few recent IPOs have done well
Krassen Dimitrov
· 7 months ago
You know, it kinda makes sense... Why were Citigroup and General Motors deemed suitable for public ownership, yet disruptive young technologies were not? That made no sense; both C and GM turned out to be risky money-losers for shareholders... "Creative destruction" is the name of the game, why not let the public own a piece of the "destructors", and not only of the "destructees"?
DorianBenkoil
· 7 months ago
sorry: they figure "it" (Sarbox) cost them $25-40 MM
fredwilson
· 7 months ago
leaving a comment at Alley Insider to prove to my friends that this is the same comment thread currently running at AVC
vruz
· 7 months ago
some things like the 'like' and 'report' buttons are not working for me. but most of the functionality seems to be doing good. it's a good idea that comments travel together with the original article and without having to create yet another account on this website (posting from Silicon Alley Insider).
Daniel Ha
· 7 months ago
I think this is because of a CSS conflict with this page. Taking a look now... thanks!
fredwilson
· 7 months ago
They (disqus) need to package that 'embed this comment thread" functionality better and make it easier to find and do
Kevin Cimring
· 7 months ago
Hi Fred,
I especially agree with your point 4, that investors are going to "look for simple businesses, products they can understand, balance sheets with cash and not much else, and growth without leverage".
We've been beguiled too often by smoke and mirrors - its time to return to basic business principles no matter what industry the company being evaluated may operate in.
ventureblogalist
· 7 months ago
Fred, at institutional level, is a stronger effort required by i-banks to market IPOs or more so that buyers need to roll up sleeves give more consideration to these opportunities.
fredwilson
· 7 months ago
I think the buyers want to own stocks that will make them money, plain and simple
There is the issue of small caps and floats
I don't have a good answer for that
I-banks that are focused on this oppty can help but its not the primary issue in my opinion
Mo
· 7 months ago
great points regrading the potential of IPO's coming back sooner rather the later, I hope you are right!
All Comments
The new entrepreneurs will develop and trade in ideas and communities. “Intellectual property", Bill Gates once said, "has the shelf life of a banana”. Without constant innovation you won't survive. The greedy and lazy VC's will probably compete for the crookedest enterprises available and the Smartest VC's will probably become social entrepreneurs.
"A business that makes nothing but money is a poor business. " -- Henry Ford
http://www.avc.com/a_vc/2006/12/web_20_is_a_gif...
- engineering. It's never one idea that's enough. You need constant innovation, and for that you need to create at least a small environment of people with slightly different backgrounds. Most ideas are replicable with the same or different technology. Take page rank for example. It's easy to replicate and there are different technologies that do the same. In fact, Jon Kleinberg's work predates Google (also note it did not appear in STOC/FOCS, but rather SODA and lower tiered conferences -- you may wonder why). Therefore, just for quality (in this case websearch) you need to constantly innovate.
- PM: users are changing. Innovation goes beyond eng, and again, you need lots of talent to keep on top of the users. Just show me a tech company that fully understands its users.
- sales: if you need sales, you'll most likely need size to scale.
- ops, infrastructure, marketing, legal, etc.
I'd love to buy into the idea that a start-up wont need size to scale fast. I'd love to buy into Ruby on Rails and other platforms. I agree that all this technology will make it easier for start-ups, but in a winner takes all environment, the lack of funds is poison.
Althought I do like the idea of having many different companies doing what one big company does today - e.g. I rather have 20 different Fords then just one really big Ford.
Regarding the IPO market - two thoughts - Do you really see signs or are you just hopeful? If the window does open, will there be a mad dash and will the first ones there (not necessarily the best one) get the cash?
"A business that makes nothing but money is a poor business. " -- Henry Ford
Until we see more commitment for the apps, this sector will not develop. Maybe a platform to show adds, or in-house protection for apps with backends. The time for a quick buck from the Apple store seems to be over.
Android to the rescue!
We need to restart the virtuous cycle. Positive articles will probably bring a positive effect along with them. :)
Andy - agree, will definitely be interesting to see the affect Facebook and LinkedIN IPOs have on the marketing :-)
(Surprised Disqus doesn't have edit for Facebook Connect comments)
I run a public company and have dealt with this nonsense for years. I am contemplating not complying at all with 404 --- which is a glorified bunch of Visio flow charts and written explanations pertaining to "critical financial controls" culminating in an opinion from management that its "financial controls are adequate" and a review by an auditor who says the same things --- more likely "management's opinion is reasonable".
It is all one step removed from fingerpainting or paint by numbers. It is as relevant to business as a debutante party is to national defense.
If you fail to comply with 404 -- which means you do the Visio nonsense and the write ups but don't submit it to be reviewed and audited --- then you simply footnote your 10K and disclose this fact. It is very, very difficult to ascertain whether you have any real penalties and what exactly the SEC or PCAOB can do to you as long as your disclosure is adequate. I will let you know about a year from now.
Public companies which now must be "reviewed" quarterly and "audited" annually and 404-ed annually are incurring annual audit fees that are about $50K per $10MM in gross revenue with about an additonal 25% for quarterly "reviews" and about the same as the annual audit for the 404 compliance.
Having said all of the above, it is a worthwhile exercise to engage in the Visio-ing of critical financial controls but it is probably a better expenditure to buy a FIDELITY BOND and create a financial reserve for losses.
I have had one big embezzler who got me for $250K and had a fidelity bond with a $1K deductible which cost me (20 years ago) an annual premium of $900. Best financial control I ever enacted.
As long as multiples don't get on a frenzy ride, and we stay grounded on earth, and greed doesn't replace common sense.
Single "idea" tech or internet companies that came out at those multiples were unable to sustain growth rates of 20-25% for any period of time and historically saw their profit per transaction declining as the technology matured (e.g. Schwab v the traditional brokerages).
Those multiples are the multiples of seasoned, predictable, stable public companies with sound management and multiple sources of cash flow. Even then, they are aggressive. A growth rate of 15% annually for 10 years (a la GE) is a show stopper. It is the 10 years which is more important than the growth rate.
The lens through which you are viewing the marketplace seems unaltered by recent experiences. The world is not going to return to from whence we have recently come, it is going to fall down a number of parallel curves and will have to rebuild public confidence and deliver returns BEFORE there can be any movement toward those kind of multiples.
I also suspect that there is some real damage in the distribution infrastructure for IPOs with the chaos in the brokerage business.
Keep saying Dr Koop and keep thinking about Dr Poop.
I think the VC backed IPO market is going to have some real challenges not the least of which is the perceived exit strategy of the VCs --- will the public embrace them cashing in at the IPO stage? I don't think so any time soon. I do think the public will be able to understand and embrace a measured exit over a period of time.
In the new reality we are living in, a sustained 10-13% return will become a very good return for new businesses.
People need to focus on profits, not revenue if you want an IPO market back. The old, tried and true metric was 3 quarters of operating profit with operating income in the double digits as a percent of revenue.
I think 15-20x current year is about the same as 12-15x forward if it’s a growth company
I have a follow up question - how do you see this IPO market taking shape? By that I mean will we see more dutch auctions in the future rather than the traditional IB route with its overblown and largely discredited fees structure?
Undertakers? Maybe! LOL
The disclosures which are made to be get a company public are so onerous and frightening as to have completely numbed the investing market's sensitivies. If everything can kill you, then nothing is really frightening.
If Amazon can sell books printed "just in time" directly from the publishers warehouse and in effect collect their revenue BEFORE they incur the actual expense, then it will become very, very easy to sell equity in the same manner.
There is no known substitute for competition, competitive bidding and a well run auction particulary when it can be oversubscribed and you can take only the highest bids for the appropriate number of shares.
Interestingly enough the high end auction houses have known this for years and have long ago incorporated phone and internet bids in their auction process.
The biggest problem is going to be the securities licensing issues but companies will simply have a designated person on their staffs go get appropriately licensed. A reasonably intelligent person could get the necessary licenses in about a month of study.
If one distilled the essence of the Schwab, Fed Express, Amazon, Yahoo, Costco, Sam's Club business experiences --- at the end of the day all DISTRIBUTION businesses, it is very difficult to see how a company could not get itself public in a credible auction particularly with the emerging secondary market for the public trading of seemingly private securities driving things.
And why not? Wall Street has been rigged for a considerable time and now it is time to expose the man behind the curtain!
Exactly, Fred. Don't know if I already have said this, but I believe the dot com effect still hangs over the sector's shoulders (regarding IPO's). Put simply, the internet bubble was all about ideas, not about the people behind the ideas (Technical Analysis vs. Buffet Value Investing). Everyone had an idea for an internet company. You simply take an idea from the real world, and apply it to the online world. Obviously, with the “newness” of the internet, VC’s couldn’t invest in teams with a profound amount of experience in the realm. Nothing mattered except the idea. It had to be big enough to pump up, inject false hope and hopefully ride the cash-loss wave until you dished it out to the public via IPO. The best VC’s were those who could make an idea look glamorous and complete the IPO before people discovered there was no business model. Not saying you did that, when I write this, I'm thinking more along the lines of the *cough* draper fishers *cough*
- Scott from http://scottdig.com
1) With hindsight, would you say this is still true? Or is it now more? Less? Have different variables come into play?
2) If the VC industry has been overcapitalized (as illustrated in your articles last week), and if the rule of thumb per venture is $20 million still, does this mean that too many of these have been funded?
3) Alternatively, is it the case that much more than $20 million has gone into many of these because of high VC liquidity, the result of which being that revenue/EBITDA pressure may have been put off or eased?
I ask these questions from the perspective that some of these factors could impact the IPO market as well, in addition to the capital markets demand side you describe above. I'm guessing, because my crystal ball is foggier than most, but I would say that the M&A market would have to rebound first before the IPO market does. One, strategics could probably handle the risk profile more easily and even assign value to pre-revenue or low-EBITDA businesses. Two, public equity investors could derive some confidence from a more positive strategic M&A market.
Its like managing a real commmunity
So I stand my by 'web 2 is a gift' now more than ever. I'm living it
As for IPO vs M&A, my gut tells me the IPO market will come back first for the simple reason that entrepreneurs have gotten wise to the costs of selling out to big cos
Not one of the companies I work with that is scaling rapidly wants to sell out
There's gotta be a way they can keep growing by letting the leadership navigate in the dynamic tech industry and still satisfy the public requirements. There are great advantages to staying private, but venture pushes towards liquidity events and IPO just happens to be a channel (sell the company to the public).
Market trend guessing game: I'm expecting one more drop before we get our economy aligned to steady growth. Although nothing's certain there has already been a large shakedown of multiple sections of US economy: banking/real estate/auto. How many more big sectors do we have that can get pruned down? Energy?
That doesn't solve the issue of returns for the asset class, since many of today's great companies were financed well north of 10-12x today's EBITDA, but unfortunately I think that is part of the process of making the ecosystem healthy again...
Is an IPO a funding mechanism for the company itself or is it an exit, liquidity event for management and the original backers?
Is the company accessing cheaper capital or is it cashing folks in?
The secondary offering as a means of accessing cheap capital is a lost art form in part because of how cheap debt has been recently priced.
There was a time when going public was a huge benefit in and of itself --- it provided access to capital (both debt and equity) on a cheaper basis. I fear that now it is viewed more frequently as having no real future value but rather creating liquidity.
I don't want to buy something when really smart guys are selling the same thing.
Without quibbling, it is certainly possible to make a sound argument and distinction between the relative skills of VCs in the life of a company however many would say that is simply the VC's organic challenge and that an IPO is not intended to primarily serve the purposes of the VCs but is an orderly and regulated sales process intended to protect the "new" shareholders and certainly not the sellers. The promised land is a public market and a public listing and market makers for the stock with all that that entails.
In the old days, a credible underwriter's name in the middle of the prospectus meant something. Today it means nothing. Therefore everybody has got to be held to a standard which eliminates obvious conflicts of interest.
Once the company is public and a decent interval has passed, then the VCs can exit in an orderly manner based upon the public's appetite for the stock, the volume and the pricing. Nobody would argue with that is not fair.
The argument, as you advance it, seemingly creates a sense of entitlement for the VCs --- "...5 or more years of work...". So what? If the passage of time were the only determinate factor of creating value --- then they could sell their positions to the second, third round guys.
No, you need a "public mark" to realize the value targeted.
The question continues to be are we creating liquidity events or building great companies? I don't care which it is frankly, as long as nobody pees on my leg and tells me it's raining.
If the only way out is through an IPO then everybody better make damn sure we don't create any more Dr Koops. Or be prepared to suffer the consequences.
I'm wondering when Fred will get wise and start his own accredited online blog university for the venture capital market. Real investors like yourself Will, make the experience of reading/commenting on Fred's blog priceless.
Since there's already a strong secondary market, validations and sharing of company information (books) must already be happening.
I think your conservative pricing approach would be a great way to get things started. As far as there being liquidity but not having VCs exit: As a public investor this would build my confidence in the offering if the people who helped make the business attractive (and hold executive positions), have a continuing vested interest.
Continually learning about asset class market limitations, there has to be a realistic value/return (correcting expectations)
I'd wager students following your blog actively (commenting, reblogging) for a semester would gain AT LEAST as much information as they would in 2 MBA courses.
And they'd have better retention of the material and greater understanding as well.
Valuing these businesses reasonably and setting the proper expectations for growth and earning power is important
I also think lockups should be structured differently. Instead of letting everyone out in 180 days, we ought to break it up in fifths and let everyone free for 20pcnt every six months
I agree completely. One of the companies I founded in the late 90's (Zero-Knowledge Systems - who you may remember from Mike Santer's role in the company) followed the same path of many of our dot.com brethren. We raised $50+ million, grew too fast & in undisciplined ways, faced the disastrous 2001-2003 tech restructuring but unlike many at the time we survived. Since renaming itself (now Radialpoint) and after a recap to clean up the balance sheet the company it has been profitable since 2003. It now has revenues that that rival many public companies, 40% year over year growth and 40% EBIDTA profitability.
Like Stuart Ellman's comment, the company has been in a position that it could have gone public anytime in the last 3 years. Given the costs associated with being a public company and the mood of the markets we choose to do a late stage private equity deal with TA Associates in September 2008 for $98 million instead of going public. Since the beginning of 2009 we have acquired two companies that further accelerate our growth & penetration into our customer base while remaining very profitable.
I know that we are not alone as I've spoken to a number of companies that survived the dot.com crash or were founded during the 2001-2003 timeframe who have revenues around $75-$100 million and are very profitable. Like ourselves, these companies are using the current economic downturn to acquire strategic assets and will emerge as much stronger companies when the IPO drought ends.
While not all will choose to be public companies, we have hugely profitable companies with employees and shareholders (and founders) who will want a path to liquidity. When the market does recover I expect a large number of very healthy, annuity based businesses to come to market giving the industry & public markets a new confidence in technology IPO's.
Great example
Here's why:
We all know that economic resources are scarce.
However, it has been the policy of Bush/Obama to prop up, bailout, and inflate. In other words, forstall necessary liquidatations, keep people working in industries that should go under, and keep prices *artificially* high.
It's a battle against economic reality...and reality always *ultimately* wins.
In my view, this is not healthy soil for viable IPO's *in general*.
However, the time will arrive where it's obvious to everyone that bailouts, inflation, and silly new-new deal's can't work.
At that point the ground will be fertile for some of the most spectacular IPO's imaginable. Resources will be available, business-harming regulations will be scrapped, and entrepreneurialism (rather than lining up at the trough) will be the motivating force.
We're *obviously* not there yet.
Now, though, we're finally seeing some decent companies (esp. Rosetta Stone) come to market with good financials and reasonable valuations . . . and they're not getting hammered.
Wouldn't that (mini-)trend tend to support your case here?
but most of the functionality seems to be doing good. it's a good idea that comments travel together with the original article and without having to create yet another account on this website (posting from Silicon Alley Insider).
I especially agree with your point 4, that investors are going to "look for simple businesses, products they can understand, balance sheets with cash and not much else, and growth without leverage".
We've been beguiled too often by smoke and mirrors - its time to return to basic business principles no matter what industry the company being evaluated may operate in.
There is the issue of small caps and floats
I don't have a good answer for that
I-banks that are focused on this oppty can help but its not the primary issue in my opinion
http://www.renaissancecapital.com/ipohome/Revie...