January 22, 2001

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Redefining Business

Free Advice:
What Does It Take To Do An IPO?

The party's over, and getting financing at all right now is a victory

By Spencer Punter

ast month, my colleague John Hurley and I sat before an audience of entrepreneurs in Silicon Valley and attempted to enlighten them on what their prospects are for initial public offerings, given the current free fall of technology stocks. These executives have been grappling for direction since it became clear that the public markets have no appetite for new stock offerings. It's no exaggeration to say hundreds of once-optimistic technology startups, facing months of negative earnings, live in fear of bankruptcy as access to funding slows down.

Conventional wisdom holds that last year at this time, companies that had no real business models were being rewarded in the private and public markets, at least in the short term. Companies were being financed based on the size and opportunity of the sector in which they were competing, not on their ability to attract and sustain customers to extract real value. On closer inspection, though, it's not just the high-flying IPOs of the last two years that face financial quandaries.

The steel mills of the Internet infrastructure have been hit hard. Intel twice lowered forecasts last year, and its shares fell 27% after rising 39% in 1999. Microsoft plummeted 63% as it cut sales and earnings estimates and faced the possibility of an antitrust breakup after rising 68% in 1999. Even Cisco Systems, which hasn't missed any financial targets, declined 29% last year. There's no shelter from this storm. And whether you're an entrepreneur at a small company or an executive at a major multinational company who does business with startups, it's critical to understand the changing market for private and public capital.

It would be imprudent for anyone not to understand that the financial markets have changed dramatically. That's true even for entrepreneurs or investors who understand how to capitalize on building the new physical infrastructure of the Information Age. We've seen too many entrepreneurs suffer self-deception, somehow believing that they'll still be able to raise vast sums of venture capital. It's over, and it's time to husband what resources we have to attain concrete business goals. And a primary goal is getting financing. Companies don't fail because of a low valuation. They fail if they can't raise capital.

Company valuations typically lag the public markets by approximately six months. That's how long it takes for private-company executives to realize their world has been altered. A company's officers should speak with buyers of public technology stocks to test sentiment or buying interest, not discuss it with their favorite venture capitalists. The last thing executives want is to shop their financing to top-tier VCs at an egregious valuation. That yields two potential scenarios: ending up with second-or third-tier investors willing to pay a high price just to get in on the deal, or calling back the first-tier players, offering a lower valuation, and losing all leverage.

Should a company consider selling itself rather than attempting an IPO? Consider selling when it's taken longer than hoped to develop the product or when the engineering team has frequently missed significant milestones and the company has lost any market lead its technical team may have had. Remember, being taken out by a larger player offers considerably less risk than going it alone. Entrepreneurs should compare the returns from a sale to what the stock price could be when they can sell their stock, which is usually six months after a deal is done.

It's still possible to consider an IPO when the sales, marketing, and engineering teams have demonstrated a string of hitting quarterly plans--at least four straight quarters, not just one. Be aware that if you link success to one metric--such as employee growth--investors will react negatively if it doesn't continue rising. Finally, the accounting of a company considering going public should be as transparent as possible.

As Internet technology spreads across the economy, the pace may be uneven and the impact uncertain for companies large and small. But this much is certain: There will always be great demand for technology products that are innovative, better, cheaper, and more reliable. The economics going forward are simple: There will be a handsome payoff for these solutions.

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Spencer Punter is general partner at Bowman Capital. He can be reached at spencer.punter@bowmancapital.com.

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