There doesn't seem to be a week that goes by without someone lamenting the sorry state of the venture capital market or our favorite exit ramp: the IPO market. Granted, the overall number of offerings in the past 7 to 8 years has been paltry. Notable individual exceptions are Google (2004), SynchronOSS Technologies (2006) and, more recently, Open Table and SolarWinds (both 2009). But let's face it: if yours is a venture-backed company, you have had higher odds of being struck by lightening than going public in this first decade of the 21st century.
"Why" is the biggest question people ask. Is it too much regulation (Sarbanes-Oxley most notably)? Is it the investment banks? The famed four horsemen (Montgomery Securities; Robertson Stephens; Alex. Brown; and Hambrecht & Quist) rode off into the sunset, never to be seen again. Did too many people get burned by the IPO market in 1999/2000, never to return to buying IPOs? All of these factors must have some bearing on the vibrancy of the IPO market, but they are more about the "ease of getting public," not the underlying issue that is the real culprit of the dearth of IPOs: we just didn't have the numbers. The IPO swamp was drained in 1999/2000, and we had to start basically from scratch.
If we think of IPO success in a supply/demand context, we can break it down even more granularly:
- Supply = companies that can successfully complete an IPO,
- Demand = institutional and retail buyers,
- Intermediaries = the investment banks that underwrite the offering,
- Regulations = the rules that govern the whole process.
We have had significant "breakage" in all four categories. The regulations are much more onerous and expensive with Sarbanes Oxley and the rules that govern investment bankers who work with analysts. The market share-leading intermediaries for IPOs of the '80s and '90s are gone. The bulge-bracket banks are willing take a company public but have thrown in a $25 million per quarter run rate as the bare minimum (have they heard of emerging growth companies?).
Those on the demand side of the equation lost money on so many of the prior new issues that they have turned their collective backs on new IPOs. As a result, the demand side dried up these past few years and focused instead on the perceived "risk-free" returns of CDOs, exotic alternatives, and powerful hedging strategies, all of which took risk capital away from emerging growth companies.
The supply side, though, is where we have had the most problems. Any company that could go public in the bubble days did go public, regardless of merit. Companies that would have normally been an 2003-, 2004-, or 2005-vintage IPO class went public in that surreal period of 1999/2000 or went out of business because they lost all access to capital, whether public or private. Perhaps no one realized it or we didn't want to acknowledge it, but building long-term sustainable value takes time, and we have been in rebuilding mode for over 8 years.
The IPO market for the second decade of the 21st century will be driven by companies formed after the bubble (i.e. late 2000/2001 and later). Historically, a venture-backed technology startup has required an average of 5 to 7 years to complete an IPO, and more recently that timeline has extended to 7 to 8 years. Mathematically, we are just beginning to enter a period when, collectively, there should be enough companies in the pipeline that conceivably have even a chance of going public.
More intermediaries and buyers will most definitely enter the fray for IPOs if the demand side of the equation believes that good money is to be made with this supply wave of new innovative companies. These IPOs in the next few years will have revenue models tied to:
- The evolving social network economies of Facebook, Twitter, and WordPress,
- Enterprise customers using Amazon Web Services and cloud computing applications,
- Breakthrough clean technology processes.
None of those aforementioned companies or trends was present in any meaningful way during the last great period of public offerings.
So, stay tuned: it's bound to be a little bumpy along the way, and it will not go from 0 to 60 overnight (the pump has to be primed, as they say). But from our vantage point at the earliest stages of tech financing, some dynamite stuff is coming in the next decade to a public market near you.