By Alastair Goldfisher
Venture Capital Journal
January 01, 2007
Acquisitions and IPOs on foreign exchanges look most attractive in
New Year
Except for the spectacular sale of YouTube to Google, exits were so-
so for VC firms in 2006, prompting many venture capitalists to
consider exit options abroad.
Most venture capitalists expect portfolio companies considering an
IPO to take a look at foreign exchanges in 2007, according to a
December survey by the National Venture Capital Association. Nearly
60% of those surveyed said foreign exchanges would be more attractive
as an IPO option for their portfolio companies, while less than 30%
disagreed.
AIM, London Stock Exchange’s market for younger companies, has grown
in popularity as it offers companies fewer regulatory requirements
and cheaper fees than its U.S. counterparts. More than 200 companies—
including about a dozen based in the United States—raised nearly $17
billion last year through IPOs on AIM, fueling talk that London was
going to surpass New York as the financial center of the universe.
After all, Martin Graham, director of market services and head of
AIM, came out and said that no way in a million years would his
exchange “move to an insane regulatory system like Sarbanes-Oxley.”
But the AIM index of all shares on the exchange was slightly down as
of late December, compared with a 16% rise in the Russell 2000, the
U.S. index for small company stocks.
“AIM has done a great marketing job, pitching itself as the next
Nasdaq for startups to go public, but it’s not as robust a place to
raise capital,” says Cabot Brown, co-founder and partner of Seven
Hills, a San Francisco-based investment bank that focuses on M&A
advisory services and private placements.
Brown and his partners say that AIM is better suited as a late stage
financing vehicle, rather than as a liquidity event for a VC-backed
startup. Of course, that hasn’t stopped Seven Hills’ clients from
asking about whether they should go to AIM or other foreign exchanges
to exit or raise cash.
M&A front
But, says Brown, “Historically, and especially in the last few years,
mergers and acquisitions have been the exit of choice for most
companies, and nothing we see from AIM will change that in the future.”
The vast majority (77%) of venture capitalists surveyed by the NVCA
said they expect M&A to be a “robust exit of choice” this year, while
nearly half (47%) said they expect the U.S. IPO market to remain
sluggish in 2007.
In fact, 2006 was a so-so year for venture-backed M&A. A total of 325
VC-backed companies were bought in 2006, for a disclosed value of
more than $16 billion, compared to 364 M&A deals in 2005 at a
disclosed transaction of nearly $21 billion, according to preliminary
year-end 2006 numbers by Thomson Financial (publisher of VCJ). Though
the volume last year was down from the year before, Seven Hills
expects activity to pick up in 2007.
J.P. Christen, a Seven Hills partner, says that consolidation,
particularly in the enterprise software and health care sectors, will
continue for the next two to three years.
Likewise, the transaction services group of PricewaterhouseCoopers
maintains that 2007 could set a new record for M&A transaction
volume. That’s in large part due to leveraged buyout firms, such as
Bain Capital, Blackstone Group and Texas Pacific Group, which have
raised megafunds exceeding $10 billion. Now that PE firms are flush
with cash, they have more arrows in the quiver than ever before, says
Greg Peterson, a partner in PwC’s transaction services practice.
“The exit market will remain robust for venture-backed companies that
seek non-IPO exits, so look for an active trade sale market and a lot
of interest from the over-funded LBO market.”
Charles Rothstein, Senior Managing Director, Beringea
Peterson points out that in 2006, private equity contributed more
than one-third of all mergers and acquisitions involving U.S.
targets, compared to about 23% in 2005, and the 10-year average of 17
percent. “With fund-raising hitting new highs, large private equity
firms continue to have ample amounts of capital that needs to be put
to work in the coming year,” he says.
A growing number of VCs are talking about the potential for exits
through sales to buyout shops. Asked to make a prediction about the
New Year, Charles Rothstein, senior managing director for Beringea,
said: “The exit market will remain robust for venture-backed
companies that seek non-IPO exits, so look for an active trade sale
market and a lot of interest from the over-funded LBO market.”
Similarly, Gerry Langeler, a managing partner at OVP Venture
Partners, quipped: “PE firms are the new M&As, M&As are the new IPOs,
IPOs are the new foreign markets.”
An overwhelming percentage (71%) of the venture capitalists surveyed
by the NVCA said the purchase of portfolio companies by private
equity firms will “become a more attractive exit option in 2007.”
Some VCs aren’t buying it. Sunil Dhaliwal, a partner at Battery
Ventures, finds it difficult to fathom that PE firms will buy a large
number of startups in 2007. Most startups are too small to register
on the radar screen of a massive PE fund. Likewise, tech companies
don’t get much strategic benefit in partnering with a PE fund.
Battery saw three of its companies get sold: Kashya Inc. Broadbus
Technologies and Ciphertrust Inc. It also had its share of IPOs. Two
of its portfolio companies went public (Omniture Inc. and Optium
Corp.) and another, Veraz Networks, was in registration as of late
December. Dhaliwal is optimistic that IPOs will rebound this year as
startups launched during the despair of the Internet bubble in 2000
and 2001 have matured.
Isilon offers hope
Indeed, IPOs started to pick up in December, and the 2006 IPO market
surpassed 2005 in terms of volume and dollars raised. As of Dec. 19,
57 VC-backed companies went public on U.S. exchanges, one more than
the 2005 tally, according to Thomson Financial. Better yet, VC-backed
IPO proceeds topped $5.2 billion, easily surpassing the $4.5 billion
raised in 2005.
Although last year was an improvement, it still fell short of 2004,
when 93 venture-backed companies raised $11 billion through initial
public offerings. Also, it is taking longer for VC-backed companies
to go public. The median age of a VC-backed company that went public
last year was 7.82 years, up from 6.13 years in 2005 and 6.86 years
in 2004.
Still, Dhaliwal holds out hope that the New Year will be better. As a
bellweather, he points to the success of Isilon Systems. The Seattle-
based digital media storage company went public on Dec. 15, raising
$108 million and posting the third best opening day of the year for
all IPOs. It made for quite a Christmas present for the company’s
venture backers, who collectively owned about 40 million shares worth
more than $950 million as of Dec. 20. Atlas Venture, Madrona Venture
Group, Lehman Brothers and Sequoia Capital had previously invested a
total of about $70 million in Isilon starting in 2001. There is hope,
then, for dot-com era companies.
As for what exchange other VC-backed companies will opt for, Dhaliwal
has no doubt that it will be U.S.-based. “AIM offers an interesting
funding opportunity for some companies, but it is not a liquidity
event,” he says.
Additional reporting by Lawrence Aragon and Dan Primack.
