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newsletter - first quarter 2004Ventures West News
We are pleased to announce that Dr. Paul Kedrosky, an internationally recognized investor, essayist, academic and speaker, has joined the firm as a Venture Fellow. Dr. Kedrosky will be involved in sourcing and evaluating deals, and providing advice and analysis on a wide range of venture capital issues. He provides Ventures West and our entrepreneurs a unique and valuable viewpoint on the venture capital and information technology industries, from both an academic and a practical perspective.
Most recently, Dr. Kedrosky has guided portfolio investment decisions in commercializing faculty research within the top-ranked Jacobs School of Engineering at the University of California, San Diego. He also lectures at UC San Diego on all aspects of early-stage and fast-growing companies. He is currently an adjunct professor in the Management of Technology program at Simon Fraser University, and he was formerly a faculty member at University of British Columbia.
Dr. Kedrosky founded the technology equity research practice at brokerage firm HSBC James Capel (Canada) and was also a founder of a private equity fund in San Diego. He is an advisor to various venture-backed private companies, as well as having founded two companies.
Dr. Kedrosky is a distinguished academic, with more than three hundred sole-authored academic and non-academic articles. His writing has appeared in the Harvard Business Review, the Economist, the Wall Street Journal, the Brookings Institute, Forbes, and the Toronto Globe & Mail. He currently writes a weekly business column for the National Post, a monthly column for Canadian Business magazine, and regularly on technology finance for RealMoney. He has also appeared on CNN, CNBC, PBS Newshour, CBC, and ABC Nightline. Liquidity Events
New Companies Funded
Articles and Opinions
The IPO Window Is Opening - But Should Everyone Jump Through? By Sam Znaimer, Senior Vice President
For VCs, the ultimate goal of any venture capital investment is to make a profit while achieving liquidity during the lifetime of the fund. Since the bursting of the tech bubble in 2000, exit opportunities, even for the best companies, have been few and far between. In the last 2 quarters there has been a marked increase in both IPO and M&A activity. The advent of the Google IPO, in particular, suggests that both investors and managers are ready to party like its 1999, and once again enjoy their most favoured exit strategy. But is the IPO really the best way to go?
On the Canadian IPO front, we have seen the return of technology company IPOs to the Toronto Stock Exchange. Workbrain Corp., a Toronto- based provider of enterprise workforce management solutions, got the wheels turning in November of 2003. It was soon followed by Guest-Tek, a Calgary based high-speed Internet access provider, and Xantrex Technology, a Vancouver based developer of advanced power electronics products. More recently, Q9 Networks and 180 Connect have pushed their way through the IPO barrier. Meanwhile, 13 venture-backed companies raised $2.72 billion through initial public offerings in the US in the first quarter of 2004, and several blockbuster offerings from the likes of Google and Salesforce.com are now eagerly awaited. It is easy to see why entrepreneurs might be thinking, once again, of holding out for an IPO.
Meanwhile, improving economic times and dazzling stock market returns have reinvigorated the appetites of established players for purchasing Canadian earlier stage companies. The activity began last year after a two-year drought with the acquisition of Crystal Decisions by Business Objects for over US$800 million and continued with Sophos PLC's acquisition of ActiveState, Intel's acquisition of West Bay Semiconductor, Ciena Corp.'s acquisition of Catena Networks for US$487 million, CDC Software's acquisition of Pivotal Corp. for US$56 million, @Road Inc.'s acquisition of MDSI Mobile for US$86 million, and UT Starcom's freshly announced acquisition of Telos for US$29M plus future considerations. And we can't forget to mention Cray Inc.'s acquisition of Ventures West portfolio company OctigaBay Systems Corp. for US$115 million.
For a long time the common wisdom has been that an initial public offering was the ultimate goal of every serious entrepreneur and their VC backers. The IPO represented a kind of coming-of-age party where the financial community acknowledged the enterprise's success, its potential for rapid and profitable growth, and the skill of the management team. Everyone agreed that there was a premium of perhaps 20-30% for public companies over their private counterparts, pleasing all the shareholders. Further, once the shares started trading, the entrepreneur would be free of the strictures of shareholders' agreements and a VC-dominated Board of Directors, as well as presented with compensation packages that are far more generous than those available to venture-backed private companies. Backed by the strength of its market value, the public company would enjoy tangible acquisition currency to support its growth mandate and sustain much greater levels of market visibility. Moreover, should the firm ever require additional capital, the pool of investors and financing mechanisms (common shares, preferred shares, convertible debt) is much broader in the public arena than in the narrow world of private equity, and these funds can be accessed quicker, easier, and cheaper than comparable private equity financings.
So why would any entrepreneur choose to sell the firm, if a public offering was available?
Well, the last few years has taught everyone about the downside of being a public company.
First, public offerings don't provide anywhere near the liquidity of acquisitions. With public offerings, investors typically face six-month lockups imposed by the underwriters only to be followed by several years of limited liquidity due to small public floats, limited analyst coverage, and thin trading volumes. This situation is much worse for management and founders, who are restricted by insider trading rules and company trading blackout policies. When they are finally able to sell, they must deal with the negative PR image of "dumping" shares of the companies they have created. There are far too many examples of entrepreneurs who have had to sit and watch their paper wealth disappear during the 2000-2002 downturn. As well, with Internet accessible databases carrying every detail of their compensation, stock, and option dispositions, there is no privacy for anyone closely affiliated with a reporting public issuer.
Second, in the age of Sarbanes Oxley, public companies must deal with life under the microscope. Public disclosure policies mean that the firm's strategies, operations, and financial performance are matters of public record, open to suppliers, customers, and competitors alike. The tangible costs of complying with all the accounting and disclosure rules is especially high for newly minted public firms. Liability insurance, audit and legal fees, investor relations, and Board of Directors costs can easily reach $1,000,000 per year. All of this occurs just at the time the firm is striving to establish a strong track record of profitability.
Moreover, the business of being public frequently distracts from the organization's core focus. Visiting with market analysts, ensuring that governance concerns are properly addressed, meeting public guidance and quarterly targets, and managing volatility become a permanent drain on senior managements' time and energy.
An exit via acquisition has multiple advantages, above and beyond just providing an alternative to going public. In terms of returns, an acquisition can provide two potential benefits - size and speed. As previously discussed, achieving liquidity after an IPO can be troublesome for a shareholder. The first few years post-IPO are especially volatile times for a firm's market value. Frequently, a firm's share price will drop from the IPO value to a value equal to, or less than, the company's comparable acquisition value, before investors and management can sell their holdings. A cash acquisition removes this risk and provides management and investors with immediate liquidity at a fixed value. An acquisition for stock of the acquiring company usually entails shorter holding periods and a much more liquid stock. When it comes to the speed with which the investor's position is liquidated, the IPO route not only puts the absolute value of the shares at risk, it also almost always stretches out the time taken to collect this value. For a venture investor, the time-based measure of IRR (Internal Rate of Return) is a very important factor. Because of this, the IPO value must have a significant enough premium over the acquisition value to make up for the time it will take for an investor to get their cash return.
There are other "soft" benefits for the venture investor in going the acquisition route. For example, by selling a company, the venture investor (who is presumably also a board member) is immediately freed of the time commitment associated with that portfolio company, making room for a new investment or deeper commitment to other portfolio companies.
It is easy to see that there are significant pros and cons to the IPO and M&A routes. For a company fortunate enough to be in the position to decide its fate, this is a critical choice that must address the needs of multiple stakeholders including management, investors, employees, customers, and community. Although each set of circumstances is unique, it is clear that M&A is often the preferred route.
Portfolio Companies' Financings, Acquisitions and Awards
Spotlight - Howard Riback
Each quarter, the newsletter will feature a member of the Ventures West investment team.
Ventures West Offices
The Fine Print
If you would like more detail (monthly summaries of all Ventures West and portfolio company press releases), have any questions or comments, or wish to be removed from the distribution, please email cramsay@ventureswest.com.
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Industry data demonstrates that acquisition is the predominant exit vehicle, even when the public markets are robust, as they were in 1999 & 2000. Now that there is, once again, heightened activity in both the IPO and M&A arena, should VCs and management teams dare to select their preferred liquidity mechanism? And which mechanism is preferable?
