CEO Brain Trust » Venture Capital

Amway of the Rich

Daniel — Tue, 06 Apr 2010 05:29:36 +0000

Today I spoke with a friend that told me he just see an entrepreneur we met 5 years ago. This entrepreneur was beginning a company to custom-made dress shirts for the wealthy executives.

So the business idea was to send nice looking girls to visit wealthy individuals to their offices and sell them custom-made dress shirts, and send the shirts to be made with tailors in Hong Kong. When he told me what he was doing, I said, well cool idea and fun to hire by commission all this beautiful girls to send to my friends offices… and also I hate to shop and it would be great to have my shirts sent to my office. But on the other side, I thought, what unsexy business with little scalability and low income potential.

5 years later… very different story… today he is closing his second round of financing by a prestigious group of VC´s, has over $10 million in sales and he is on his way to create the Amway for the rich executives!!!! Wow what a different story!!!! Imagine the potential of sales of having an Amway for the rich? Amway today has sales over $8 billion dollars!!!! An sells to the base of the pyramid an mid class.

This confirms my thesis that ANY idea with a good and passionate entrepreneur perusing it can grow significantly and bring great wealth to him and the ones that trust him at the beginning. So the first thing I like to see when analyzing an investment opportunity is who is the entrepreneur behind the opportunity… I believe if you have the right entrepreneur executing and running the company, you have at least 50% chances of success in your investment.

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Seven Investors To Avoid

Daniel — Thu, 17 Dec 2009 15:54:42 +0000

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Seven Investors To Avoid
Martin Zwilling, 12.08.09, 5:04 PM ET

In a tough economy, all capital is created equal, right?

Wrong. Even in a credit-starved environment like this one, the source of your money matters. A lot.

When it comes to courting angel investors–well-heeled individuals looking to put some of their stash in promising young companies that could yield juicy returns–entrepreneurs should take great care. Some angels can be a mild nuisance, others downright conniving and unscrupulous.

Here are seven types of fallen angels to avoid.

Suit Slingers. These nettlesome types look for any excuse to take you to court. Rather than try to help your company grow, instead they try to make money through intimidation, threats and lawsuits. They know you don’t the resources to fight them and most likely will cave to their demands.

In Depth: Nine Money-Raising Mistakes

Top Tips: Six Ways to Raise Cash–Now

Smart Guys. Successful business people who become angels often have a prodigious sense of superiority. They tend to be overbearing, negative people hypercritical of every decision you make. Their money may spend, but don’t let them intimidate you into bad decisions.

Control Freaks. This kind of angel starts out looking like your new best friend. Don’t be fooled. As soon as you hit a pothole, he’ll trigger a “gotcha” clause in your agreement that gives him more ownership and operational control of your company. Only your Board can save you here.

Hand Holders. The tutorial investor is not after control, but he wants to guide you on every niggling issue. What feels like benevolent mentoring before he writes the check becomes a painful nuisance soon after. Unless you have an overabundance of time and patience, keep your distance.

Has-Beens. These angels take to wing with every perturbation in the economy. Typical profile: former high-fliers with a liquidity problem. They are still at the country club every day, but now are running up a tab. They will meet with you, ask a thousand questions, but never get around to closing a deal.

Numb Skulls. Wealth is not synonymous with business savvy. You can spot a dumb angel by listening to the questions they ask. The more superficial the questions, the less value (and more potential harm) they will bring to your organization. (That goes for financial journalists too.) One caveat: Numb-skull angels may have important and much smarter friends, so don’t disregard them entirely.

Brokers In Drag. Deal brokers posing as angels (they may be lawyers or accountants by trade) have little intent to invest in your company. Their goal: to get you to pay them to introduce you to actual investors. Brokers may be worth their fees, but don’t mistake them for angels.

General rule of thumb for avoiding fallen angels: Eschew investments from private individuals and focus on credible, professional angel-investing organizations. Even then, do your own due diligence: Ask what other companies they’ve invested in and talk to the chief executives of those outfits to get their feedback. Finally, make sure your lawyer–not the investor–writes the initial investment document or term sheet. This should be a standard document and not negotiated on a one-on-one basis. Beware requests for last-minute clauses that could come back to haunt you.

Yes, money’s tight. But choosing the wrong angel could put you on the flight path to perdition.

Martin Zwilling is the founder and chief executive officer of Startup Professionals, a company that provides products and services to start-up founders and small business owners. Check out his daily blog at http://blog.startupprofessionals.com or contact him directly at marty@startupprofessionals.com.

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Raising Capital: Equity vs. Debt

Daniel — Thu, 17 Dec 2009 15:51:46 +0000

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The banks generally still aren’t playing ball, but there are creative solutions allowing small companies to win financing

By Jill Hamburg Coplan

In November 2008, Donn Flipse was forced to close one of his three flower superstores in Florida’s Broward and Palm Beach Counties. Nine months later, Flipse expanded by acquiring the business of a retiring florist in a wealthy section of South Miami. Those two events normally would have led Flipse to lean on his $500,000 line of credit. But that credit line had been personally guaranteed by a family member who, because of a decline in that person’s own finances, was unable to continue the guarantee. Flipse paid off the revolving loan with “the only thing available”—money from two of his grown children, both of whom are shareholders and sit on the company’s board. Now, for the first time in its 19-year history, Field of Flowers, which employs 46 people and expects to bring in $6 million in sales this year, doesn’t have bank financing.

Like thousands of other small business owners with good credit histories, Flipse also found his credit-card companies lowering his limits. He plans to pay back his kids in early 2010, after the Valentine’s Day and Easter rushes bail him out. “There was no choice,” he says. He recently had to lay off two of six headquarters employees, leaving the dispatcher running the computer system. “We’re not thrilled about any of it. But the company’s a part of our lives.”

It’s not news that small companies are scrambling for credit, or in some cases, for equity investors. Entrepreneurs even appear to have caught a much weaker strain of the same virus—leverage—that helped bring down Lehman Brothers and many individual homeowners. From 2003 to 2008 the liabilities of small companies ballooned from roughly equal to sales to three times sales, according to Sageworks, a financial data company that tracks 1 million small private businesses. “In the crazy times, people were like drunken sailors—they’d project that in two years they’d double their earnings, [so they would] overvalue their companies, and as owners in love with their businesses, take on debt, right or wrong,” says William Lenhart, national director of business restructuring at BDO Consulting, which advises companies with $10 million to $15 million in sales. “They got away from the historical debt-to-equity parameters of their industries.” Banks and credit-card companies did their part, too, heedlessly throwing offers of credit at entrepreneurs. Some 636 million business credit-card offers went out in 2007, according to Packaged Facts, a research group. That works out to about 27 offers mailed to each company in the U.S.

Now, morning-after realities are prompting a rethinking of the relative merits of debt vs. equity. A rising sense of conservatism says small companies should be far less leveraged than was thought prudent 18 months ago, and should have much more generous debt-service coverage ratios. This measurement is a favorite among bankers because it cuts to the chase: Will they get paid or not? “There’s a weeding process going on,” says Joseph Harpster, chief credit officer at Herald National Bank, a New York community bank. “Banks have to be more careful.” There’s also a shift in thinking about a company’s optimal debt-to-equity ratio, or its level of debt compared to shareholder equity. Instead of financing to expand, it’s now about stashing away cash and trying to stay solvent.

Some business owners say ratios are an accountant’s problem. That’s not smart, says Dileep Rao, president of Minneapolis’ InterFinance Corp, a venture-finance consulting firm, and professor at the University of Minnesota’s Carlson School of Management. “Running your business without knowing your numbers is like driving a car without being able to see your direction or speed,” says Rao. “It’s only a matter of time before you crash.”

The terms “debt” and “equity” get tossed around so casually that it’s worth reviewing their meanings. Debt financing refers to money raised through some sort of loan, usually for a single purpose over a defined period of time, and usually secured by some sort of collateral. Equity financing can be a founder’s money invested in the business or cash from angel investors, venture capital firms, or, rarely, a government-backed community development agency—all in exchange for a portion of ownership, and therefore a share in any profits. Equity typically becomes a source of long-term, general-use funds. The share of any hard assets, such as property and equipment, that you own free and clear also counts as equity.

Striking the right balance between debt and equity financing means weighing the costs and benefits of each, making sure you’re not sticking your company with debt you can’t afford to repay and minimizing the cost of capital. Choosing debt forces you to manage for cash flow, while, in a perfect world, taking on equity means you’re placing a priority on growth. But in today’s credit markets, raising equity may simply mean you can’t borrow any more.

Until recently, bank credit was a financing mainstay. But experiences like Flipse’s underlie a point made by the Federal Reserve Board’s quarterly Senior Loan Officer Opinion Survey on Bank Lending Practices, released in November. According to loan officers, small-company borrowers were tapping sources of funding other than banks. They were being driven away for many reasons. Banks “continued to tighten standards and terms…on all major types of loans to businesses,” though fewer were doing so than in late 2008, when tightening was nearly universal. Interest rates on small business loans were on the rise at 40% of the banks surveyed, even as the prime rate reached historic lows. One in five banks had reduced small companies’ revolving credit lines. One in three had tightened their loan standards, and 40% had tightened collateral requirements. Partly because of the plunging value of the real estate securing many commercial loans, pressure from bank examiners for tighter standards continued to build. Meanwhile, home equity loans, another popular source of small business cash, had evaporated. Many recession-weary business owners knew they had essentially become unbankable: Loan officers surveyed said far fewer firms were seeking to borrow. Those few who could borrow were repelled by higher rates. All of a sudden, equity financing looked better.

But equity has other costs besides giving up some control of your company. Raising equity involves legal, accounting, and investment banking fees, which eat up at least three to five percent of the amount raised. Later, investors will want a regular stream of information. And the lower your company’s valuation, the more equity you’ll give up to raise the same amount of cash, so raising this type of financing in a company’s early stages means selling more of the business.

How much debt, and how much equity, is right for your company? Benchmarks vary by industry. And stripped of context, they don’t mean much. Fast-growth fields with potential for blockbuster returns, such as software and biotech, attract equity investors more easily. Those companies also are often unable to borrow because their assets are intangible and their cash flow uncertain. The result: debt-to-equity ratios near zero. Capital-intensive industries with high costs, such as oil and gas development, construction, and mining, tend toward high debt-to-equity ratios—sometimes as high as 10 to 1. The same high ratios can hold for banks and finance companies, as well as troubled industries, such as airlines and autos. Here are some other factors that affect the optimal ratio for an individual company.

THE STAGE YOUR BUSINESS IS IN

Are you growing? That’s hard to do using internal cash flow alone. “If you don’t have some debt, you’re probably constraining your growth,” says John Terry, a business professor at the SMU Cox School of Business. “Most often, a viable business needs cash to grow, unless you choose to grow very slowly.” How much debt is too much?

If a company is stable and well-established, tipping toward debt financing makes sense, because the company has both assets to borrow against and the cash flow to service the loans. Fast-growing startups, by contrast, lack the assets and cash flow that would qualify them as borrowers; they must inevitably tilt toward equity financing, which has a downside. “The cost of equity capital, where you’re selling off a piece of your business, tends to be double” that of debt financing, says Tom Kinnear, professor of entrepreneurial studies at the University of Michigan’s Stephen M. Ross School of Business. From that average, it regularly goes far higher, says Rao. In other words, the profits you’re giving up from the portion of the company you no longer own can be expected to be much greater than the interest you would pay on a comparable loan. “That’s a reasonably sophisticated calculation that’s not widely understood,” says Kinnear. The good news about equity is that going bankrupt because of mushrooming debt is not a concern. The bad news is that peace of mind comes at the cost of ownership and control. A demanding investor’s desire for a particular exit strategy may not coincide with an entrepreneur’s best interest. A newly launched business, however, may have no better choice.

INDUSTRY NORMS FOR ASSETS, INVENTORY, AND RECEIVABLES

These vary, depending on the type of business. If you’re a manufacturer and your equipment is valuable, it’s relatively easy to secure working capital backed by those assets. Also, banks as well as asset-based lenders will make loans against accounts receivable and certain types of inventory. Typically, they’ll lend 60% to 80% of the value of receivables that are less than 90 days old, and sometimes, 30% to 50% of the value of raw or finished inventory. Fair warning: Interest rates at asset-based lenders will typically be at least two or three times the prime rate, and your credit score may play a part, too.

Industry norms also vary when it comes to solvency ratios. Again, asset-rich manufacturers with plants, equipment, and inventory that can be liquidated are well positioned for debt financing, while service or Web companies are less so, says venture investor Michael Gurau, president of Coastal Enterprises Community Ventures, which runs two regional venture funds in Portland, Me. But any company with large receivables, whatever its industry, should seek some debt financing, particularly a working capital line of credit, he believes.

COMPARING DIFFERENT FORMS OF FINANCING

Borrowing isn’t cheap right now, but it is at least accessible. The variety of vehicles include subordinated or “junior” debt (so named because it has only a secondary claim on assets in the event of a bankruptcy). These loans come at higher interest rates, but they’re available from development agencies and others. Factors and asset-based lenders may be options for distressed companies, where the owner’s personal credit rating is below 650 and the company’s net worth is negative. Higher-risk or startup borrowers that anticipate a merger or initial public offering within eight years can explore “venture debt” and similar hybrid structures that couple a loan with a “kicker” that converts to equity. But there aren’t many venture bankers around, and the most established—Silicon Valley Bank, Western Technology Investment—are in Silicon Valley. Alternative financing may also take the form of a vendor leasing program, which Flipse uses: He leases his delivery fleet from a trucking company that provides financing at 5%.

As for possibilities on the equity side, it’s sometimes feasible for companies or owners to create their own nest eggs. Pilar Peña is co-owner, with her twin sister, Ali, and her mother, Alex, of 10-year-old Forums Event Design & Production, a $2.5 million, five-person Miami company that uses a network of freelancers to put on expos, conferences, and other bilingual sales and training meetings across Latin America and the Caribbean. Recently the Peñas’ credit-card company canceled the business’ revolving credit, claiming their $150,000 balance was too close to the limit. But when the bank conducts its annual scrutiny of Forums’ $200,000 credit line, the Peñas are prepared. Besides owning residential property, they build capital by keeping half the company’s net income in the business each year. They run lean, with just two full-time employees besides the family. “If you’ve left enough equity in the business and have financial discipline in your life, you have that backup,” Pilar says. “We have our back against the wall, and it gets scary” every spring, she explains, during and after a $1 million conference for a client that takes 60 days to pay. She pushes hard on receivables and uses a factor, but the equity is the emergency fund: “It’s something that will pull you through.” The bank says the Peñas may only approach their line’s limit once a year, when they’re bankrolling that huge event.

YOUR GOALS

“The real question may not be how much you raise or borrow, but where are you putting that money? There’s good debt and bad,” says James Montgomery, a small business lawyer. “Borrowing money to generate more money—that’s good debt. Borrowing just to stay alive is not.”

One goal might be to stay ahead of rivals. If you keep expenses low and raise only a minimal amount, a better-funded rival may pass you. It’s a calculation Michael Kirban made with Vita Coco, the coconut water company he co-founded with Ira Liran in 2004 . On vacation in Brazil, they were struck by the popularity of coconut water. With $80,000 in savings and a $100,000 credit line, they began importing small quantities, which Kirban sold to Manhattan grocers and delis, making the rounds on in-line skates. Rivals were on the scene, but Kirban was ahead in sales and distribution and wanted to stay that way. In 2007, he won $7 million in equity funding, for a 20% stake, from Verlinvest, a fund created by the three founding families of European beer conglomerate Anheuser-Busch InBev. That allowed him to build a factory in Brazil that employs 30 and to raise sales to $20 million.

WHEN AN EQUITY INVESTOR OFFERS MORE THAN CASH

Some venture capital firms can help a business gain credibility by supplying advice, access to customers, and a stamp of approval. Kirban says his investor does this, too. Verlinvest “is a perfect fit,” Kirban says. “We wanted an investor-partner with in-depth knowledge of the beverage business on a global scale.” It seems to be working: Verlinvest has given guidance to Vita Coco’s marketing team, which has allowed the young company to start selling in the United Kingdom. Verlinvest also suggested a set of quantitative benchmarks that Vita Coco uses to gauge its progress.

But at the beginning, Kirban was reluctant to part with a majority of his company, which Verlinvest originally wanted. Now, although Verlinvest has a 30% stake, it also has a significant say on all employee remuneration and the ability to replace Kirban at any time. Kirban, for his part, is thrilled to have such a big player in his corner.

SIZE OF MONTHLY LOAN PAYMENTS

Just a few years ago, you may have heard this praise sung in favor of debt: You can deduct the interest payments at tax time. That’s still true. But now, burned by the downturn, bankers and entrepreneurs are turning their attention to a different issue: Can you safely project that you’ll have enough free cash flow to service that debt without spiraling downward, especially if interest rates rise? Credit analysts use a figure called the debt-service coverage ratio, which measures whether you’ve borrowed more than you can make monthly payments on. Ray Silverstein, a board member of Devon Bank in Chicago, says he’s looking for $1.50 of free cash flow to be available each month for every dollar of debt-service payments that come due. Others seek $1.20. That compares with just $1 a few years ago—and that $1 was often based on cash-flow assumptions that were, shall we say, highly optimistic. Do this calculation not only at current interest rates but at higher rates as well, in anticipation of increases. Then consider possible fluctuations in revenue and in your ability to collect on time from your customers.

Still, some people just don’t like to owe money. When Kirban was funding Vita Coco with his line of credit, he had nightmares. “Every time I’d open up our Citibank account and see how much debt we had, I’d freak out,” he says. “When we were maxed out and had very little in the bank, you believe in your business, but still—it’s scary to be personally liable for it.” He paid it down as soon as he found an equity partner.

Where does that leave us? Prevailing wisdom today holds that debt and equity should be equal (1:1)—or that equity financing should be twice that of debt (1:2). Compare that with 2007, when the acceptable level of debt, relative to equity, was twice or even four times what’s acceptable today, says Steve Romaniello, managing director of Atlanta private equity firm Roark Capital Group.

In the end, a ratio is only an analytical tool, not a magic wand. Important pieces of the puzzle, such as interest rates or sales, can move in unpredictable directions. Or as Rao says: “An optimally financed business may be obvious only in hindsight.”

To listen to a podcast interview on increasing your chances of landing a loan, go to businessweek.com/go/sb/loan

Return to the BWSmallBiz December 2009/January 2010 Table of Contents

Jill Hamburg Coplan writes about topics including finance, family, and religion, and teaches journalism at New York University. She has been a regular freelance contributor to BusinessWeek since 2000.

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Candidate Selection for an IPO

Daniel — Fri, 08 May 2009 05:56:26 +0000

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Presented to the Babson Research Conference, June 2005-03-29
By Tom Mckaskill

Principle Topic

There is little in the prior literature to help a firm decide if it is a good candidate for a IPO, although there have been a number of studies of characteristics of the firm at IPO time relative to price discounting and after market performance.
Method

This research project set out to identify those pre-IPO attributes that would contribute most to a viable IPO and a good after market performance. The initial list of attributes was established through lengthy interviews with investment bankers and professional advisors. The final list of 45 attributes was sent to around 500 executives active in the IPO process, most of them in private equity or venture capital firms. Completed surveys were returned from 93 respondents.
Results and Implications

Of the 45 attributes identified in the pre-survey work, only 25 were well supported. It seems that the level of revenue or size of the profit carries little weight with the survey respondents. The only strong indicator in terms of size and profitability of the business that is supported by the survey is the potential of the business to achieve $100 million capitalization. However, this might be predicated on having a robust business model with the right management team and a strong competitive advantage. Having a strong competitive advantage, strong industry knowledge and a robust growth strategy are seen to be important.

There is an overriding emphasis in the survey results on understanding the IPO process and having the right preparation internally and externally for the activity. This includes the right people in the management team and on the Board of Directors, the right selection of industry knowledgeable and respected advisors as well as a good understanding of the public market dynamics.

If a more robust list of desirable attributes can be developed, this will help venture capital firms and investment banks develop better strategies for IPO activities. At the same time those candidates that clearly are not able to achieve the desired attributes would be encouraged not to waste their time and money on an IPO process.
Contact : Dr. Tom McKaskill, Australian Graduate School of Entrepreneurship, Swinburne University of Technology, PO Box 218, Hawthorn, Vic 3122, Australia. Tel: +61 3 9214 8422 Fax: +61 3 9214 8381, info@tommckaskill.com

Candidate Selection for an IPO

Presented to the Babson Research Conference, June 2005-03-29
Professor Tom McKaskill
Professor of Entrepreneurship
Australian graduate School of Entrepreneurship
Swinburne University of Technology
info@tommckaskill.com

ABSTRACT

The entrepreneurship literature provides little guidance to the entrepreneur on the venture attributes that should produce a robust platform for an IPO and a good after market price. This paper assembled a possible list of such attributes from expert interviews and then used a survey of executives that were active in IPOs to show which ones were considered most important. The findings show that there are three main areas where a firm might improve their IPO success. These can be characterized as a strong business model, a good understanding of the IPO process and having the right set of advisors.

INTRODUCTION

The success of a venture capital fund is often determined by the success to which they can liquidate their investments at a profit. In fact this is a critical aspect of the of the venture capital process. The VC firm will seek to maximize their return through the exit event whether this is an initial public offering (IPO), trade sale, sale to another private equity fund, management buyout or some form of liquidation. Their preference has been the IPO as this has historically yielded superior returns to that of other exit paths (Bygrave and Timmons, 1992)(Jain, 1995)(Wang and Sim, 2001, p. 347 )(Gompers, 2001). Results for VC exits in Australia support this view. For the venture capital sector in Australia, Golis quotes an IRR of 29 percent for an IPO versus 9.5 percent IRR for a trade sale (2002, p. 42). Thus preparing an investee for an IPO would seem to be of major interest to the venture capital sector and yet little attention is given in the published textbooks and journal articles on how this might best be achieved.

The field of entrepreneurship provides little guidance to the new venture entrepreneur seeking to exit via an IPO. Most standard texts discuss the importance of creating an exit plan and normally list the alternative exit paths. The IPO is seen by many as the premium path to harvesting and yet seems to assume that the entrepreneur will either know how to structure the business for an IPO or that the entrepreneur can find this information from advisors or underwriters at the time they need it. Well established textbooks such as Timmons and Spinelli, (2004, p. 611), Kaplan (2003, pp. 427-435) and Dolinger (2003, p.230, 250-252) discuss the IPO as an exit path but give no attention to how a business should be structured for an IPO or what strategies might be employed to improve the probability of success.

There are numerous textbooks on the IPO or public listing process and on the stock exchange requirements for a listing. For example, both Kaplan (2003) and Dolliger (2003) lay out the IPO process. Aaronson (2003) outlines the listing requirements of the UK Stock Exchange and documents the role of the various parties that will be involved. Golis sets out the requirements for listing on the Australian Stock Exchange (ASX) (Golis, 2002, pp. 221-227). Apart from Golis, none of these authors discuss how a business might better position itself for a listing or how they might improve their ability to gain the support of the better underwriters or after market analysts.

In fact, very little is offered by way of pre-IPO strategies. Gladstone and Golis suggest some minimum attributes that should be achieved for IPO candidature. Gladstone and Gladstone in their Venture Capital Handbook state that, in the USA, firms are considered suitable for an IPO if they can demonstrate a growth rate of 30 to 60 percent and at least $10 million in net after tax income, however there is no discussion of other attributes (2002, p.312).

Golis states that firms should not consider a listing unless they can demonstrate the following attributes:

Valuation of at least $20 million
Support of the institutional investors such as insurance companies and pension funds where a $1 million investment would result in less than 5% ownership
Profit after tax of $1.5 -$2 million for the year preceding the float
Prospective forecast of profit after tax of $2-$3 million (2002, p. 47)

It is clear that the new venture entrepreneur that desires to list on the public stock market will gain little insight into how they should develop their business to make it more attractive for an IPO from the current entrepreneurship literature. Admission criteria to the established stock exchanges provide minimum conditions rather than desirable conditions, although minimum conditions certainly indicate where likely risk of failure can be best mitigated.

Unlike Australia, included in the criteria for admission to the UK Full List and AIM is a requirement that there is a “minimum track record of management within the business”. The firm has to satisfy the “Sponsor or Advisor” that it is suitable for admission. This might include the following;

Is the company operating in a growing market
Is the company like to grow
Is there a high quality management team
Do the directors have the experience to run a public company
Are there adequate governance safeguards
Are there suitable non-executive directors
Does the business have any significant unresolved liabilities

The Advisor or Sponsor must decide if the company is suitable for admission. (Aaronson, 2003)

Some additional insights into desirable pre-IPO attributes can be gleaned from the research on IPO underpricing and post IPO performance.

IPOs and After Market Performance

There has been some research over the last 20 years on pre-IPO firm characteristics as they relate to IPO pricing and to longer term performance and taken together these do provide a list of some attributes that the candidate IPO firm should be considering in building a strategy for an IPO. Certainly the investment bank should be sensitive to this body of knowledge in selecting firms for IPO underwriting. For example, firms that had positive pre-IPO earnings performed better than those with negative pre-IPO earnings (Yi, 2001) although on average, firms undertaking an IPO will experience a decline in their operating performance in the five years beyond their IPO (Jain and Kini, 1994).

Bagley and Duachy discuss whether the firm “is an IPO candidate” and whether it should wait until it can command a higher valuation. They discuss factors outside the firm’s control and influence such as market reactivity to IPOs, whether the market is “hot,” readiness of institutional investors to invest in the sector and industry performance. They indicate that the firm should consider the company’s existing products and product pipeline, the strength and depth of the company’s research, development and management teams, the competitive landscape and the company’s anticipated capital requirements, as factors the firm should evaluate when considering an IPO. However they give no indication of how these items might affect the IPO or how they might be shaped to improve and IPO position. (1999, pp. 407-8).

Up to 1997, the literature contained no references to “time to failure” of IPOs as that event related to firm characteristics at the time of their IPO (Hensler, 1997). Hensler states that a better understanding of the survival rates would provide issuing firms with a sounder base on which to decide whether to support a firm for an IPO. Hensler found in his study of IPO failures that survival time for IPO increased with firm size, firm age at time of IPO, initial return, IPO activity level and the percentage of insider ownership and it decreased with risk characteristics and the public market activity level (1997). Jain and Kinni (1999a) also found that firm size and insider ownership was related to IPO survival. They also found that R&D expenditure, pre-IPO operating performance and the underwriter reputations were positively related to survival rates. Jain and Kini (2000) found that VC backed firms performed better in the aftermarket, possibly due to the advice from the VC firm as well as better institutional and analysts’ coverage and the more successful IPO road-show. Welbourne found that small and faster growing firms benefit from a senior HRM executive as part of their management team (1999).

Certo et al. found that larger boards and more prestigious boards were associated with less underpricing at the time of the IPO but that greater proportions of outside Directors was associated with greater underpricing. This study did not however extend these variables to longer term performance of the firm post IPO (2001).

Few private equity investments are liquidated at the time of the IPO, instead PE investors typically dissolve their investment by distributing their shares to their fund investors one to two years after the IPO (Lerner, 2000, p. 370). Since founders and venture capital investors are often not able to harvest or exit during the IPO, a secondary offering would allow them to harvest some or all of their value. Thus an increased price at the secondary offering not only rewards the IPO investors but provides an opportunity to harvest by the founders and venture capital investors. In fact the pre -IPO investors may be better off by delaying their harvesting until a secondary offering (Prasad, 1995). Post IPO performance should be of importance to founders and PE investors.

Industry sector may have a bearing on post IPO ability to raise additional capital through successive public capital raisings. Jain and Kini note that firms in sectors which are attracting few new issues have a higher probability of failure and that the probability of survival is likely to be positively related to industry growth and attractiveness. (1999a). They also found that stronger barriers to entry and more diversification improved survival rates

THE STUDY DESIGN

The prior research on post IPO performance has been undertaken mostly by reference to data sourced from the public domain. Thus only those items or attributes which are able to be identified in public documents, such as a prospectus, have been correlated with operating performance subsequent to the IPO.

To answer the question: “Which candidates should be selected for an IPO?” the author was interested in looking at a wider range of pre-IPO attributes. However since these are not available in published documents and tracking down and interviewing executives involved at the time of past IPOs would be overly expensive, the author undertook to identify the most important attributes through a survey of IPO experts, that is, executives in investment banks, venture capital firms, stock brokers, professional advisors and corporate executives with IPO experience.

The investigation of pre-IPO attributes started with the development of an initial list through intensive independent unstructured interviews with two investment banks. The attribute lists were developed separately by each bank in conjunction with the author. The technique for generating the information was to ask the investment bank to consider a situation where the public market was neither hot nor cold, that they had limited capacity to undertake candidates and they therefore needed to develop a screening process to decide which of many potential candidates they would choose to work with. These interviews were conducted over March and April of 2003 (Buckley, 2003) (O’Brien, 2003).

In order to develop the list of “attributes” both investment banks established a similar set of desirable outcomes that they wished to achieve from the IPO activity. These were:

The level of funds sought to be raised by the IPO was readily achieved without having to offer a substantial discount to the institutional investors
The after market price was maintained or increased over several years following the IPO (relative to the general movement in the market)
The firm was able to raise additional funds on the public market at a price above the price of each prior round
The firm achieved sustainable profitable growth within several years of the IPO
The reputation of the bank with institutional investors was not damaged by the performance of the firm over several years following the IPO

These desirable outcomes are well supported by prior research.

a) Discount to institutional investors (underpricing)

The topic of issue discount has been examined by numerous authors and seems to relate strongly to the level of uncertainty faced by the IPO investor. The more that the IPO candidate can demonstrate credibility, the less the need for a discount to ensure a take up of the shares at initial issue time. This has been demonstrated through a study by Marchand et al. where they showed that, where uncertainty about the firm’s likely profitability was lower, there existed smaller underpricing ( 1996, p. 60). Lin (1996) was able to show that the reputation of the venture capital pre-IPO investor was able to reduce IPO underpricing and underwriting costs. However underpricing does not appear to convey any signaling information about post IPO performance (Jain, 1996) or subsequent equity raising ( Garfinkel, 1993).

Underpricing may also be related to underwriter [investment bank] prestige since the research shows that those IPOs supported by more prestigious underwriters tend to underprice less. This is also a signal to the market that the firm is likely to be less risky ( Chemmanur, 1994). The Johnson (1988) study shows that the more prestigious underwriters support less risky IPOs which are directly related to less underpricing.
b) After market price (post IPO price performance)

This objective seem to be achieved, at a minimum, if the capitalization of the firm over several years subsequent to the IPO is at least equal to the capitalization of the firm at the time of the IPO. Even in a falling market this could be achieved by the better firms. For example, one investment bank reported that, even with the decline in the biotechnology market in 2002, seven firms had price increases in 2002 and six others were unchanged or fell less than 10% (Intersuisse, 2003, p. 3).

Selecting the right IPO candidates is important for long term profitability of the investment bank. Jain and Kini state that investment banks need to continually attract new IPO firms, thus having a successful track record of post-IPO performance will enhance their reputation and help ensure a flow of new business (1999a). Jain and Kini (1999b) found that IPO firms taken public by a prestigious investment banker have a higher survival rate. Prestigious Investment banks typically select low risk firms for IPOs (Cater and Manaster, 1990). The same logic applies to auditing firms. The more prestigious auditing firms will want to be associated with lower risk firms ( Titman and Trueman, 1986).

Craig Dunbar studied the consequences of an IPO withdrawal by reviewing all IPOs in the United States between 1980 and 1994. His evidence showed that 20 per cent of public offerings are withdrawn or cancelled. He found that withdrawals were not influenced markedly by large swings in up or down markets and only 8% subsequently undertook an IPO. He also found that cancellation significantly affected the ability of an investment bank to get subsequent deals. His analysis also showed that the market share of all IPOs that an investment bank achieves is influenced by the subsequent performance of the listed firms (2004).
c) Subsequent offerings

Investment banks prefer to choose candidates that have the likelihood of undertaking subsequent public offerings as this leads to subsequent fees. Firms that have a successful experience with the underwriter are less likely to switch, thus investment banks need to carefully select those firms it works with. As shown above, firms undertaking an IPO wish to work with the most prestigious underwriters, thus lower risk firms will seek out a prestigious underwriter (Carter, 1990). Lower risk firms that undertake an IPO are more likely to undertake a subsequent offering and the more prestigious underwriters tend to handle the subsequent offerings. Thus an underwriter that seeks out lower risk firms is anticipating future earnings through subsequent offerings (Carter, 1992).
d) Sustainable profitable growth (post IPO operating performance)

Poor aftermarket performance emerges as a persistent feature of initial public offerings. ( Levis , 1993). Jain and Kini comment that the survival of IPO firms subsequent to going public has been largely ignored. They also state that “approximately a third of IPO issuing firms fail or are acquired within five years of going public” (2000).
e) Reputation

The ability of an underwriter to readily market an IPO stock will depend greatly on the after market performance of their prior listings. Since investors in the stock don’t have access to the same level of information as the underwriter, the investor is somewhat dependant on the underwriter undertaking the evaluation for them. The investor thus uses the underwriter’s reputation and past performance of the firms that the underwriter has previously represented as a measure of investment quality of a new listing. The underwriter that fails in their selection will end up with a lower reputation. “A lower reputation leads to lower market values for equity sold in the future, and in turn, to lower future fees” ( Chemmanur, 1994).

After establishing the desired outcomes, the author then asked the investment bank executives to identify the differences between successful IPO firms and less successful ones. That is; whether the firms that were able to maintain or improve their capitalization value in a declining market demonstrated different attributes at the time of their IPO? To assist the discussion and to sharpen their focus in determining the final list of attributes, the proposition was put to these interviewees in the following form:

“In reviewing possible candidates for a possible IPO, what are the attributes that you look for given that you wish to achieve the objectives identified above?”

The next stage in the development of the attribute list was to have the attribute list reviewed by several venture capital executives and professional advisors. These interviews were confined to clarification of the attribute wording and an evaluation of whether additional items should be added. These interviews were conducted over several months in the middle of 2003.

The final list comprised 45 attributes grouped into four categories; Alignment Activities (3 items), Due Diligence/Governance Activities (19 items), Enduring Market Requirements (19 Items) and Enduring Market Requirements (start up / technology companies) (4 items)
The Mail Survey

The next stage of the project involved a postal survey to executives experienced in IPO activity. A database of names and addresses of executives resident in Australia and New Zealand was provided to the author by the private equity advisory department of a large international accounting firm. The initial survey was sent out in early September 2004 to 504 named executives. The breakdown of the target audience was as follows:

380:	Corporate Finance professionals employed by Private Equity Houses
72:	Managing Directors / Directors of companies that have recently listed on the ASX (last 12 months)
46:	Other Fund Managers and Corporate Finance professionals
6:	Private Equity Advisors of the accounting firm

A small number were also sent to investment banks but for privacy reasons they were not willing to identify the executives that they were distributed to.

The survey requested respondents to rank each attribute on a 4 point scale using the following headings:

0	Not Important
1	Marginally Important
2	Important
3	Very Important

Additional spaces were provided for respondents to identify additional attributes or to add any comments.

Of the original mailing, 31 were returned unopened where the firm had moved, the executive had left or the address was incorrect. Completed survey forms were returned from 50 executives and a further 2 declined to complete the survey as they either had no experience or their experience was solely in exploration or research ventures which were explicitly excluded. An additional mailing was sent out in late November 2004 to the same destinations, excluding those that had completed the survey and those with incorrect addresses. This second survey yielded a further 43 completed surveys with 10 returned unopened. The response rate overall was thus approximately 18%.

SURVEY RESULTS

Each respondent was asked to indicate the number of years they had been active in the IPO activity and how many IPOs they had actively worked on. While the list had been complied specifically for the private equity market by the accounting firm, it was expected that executives that had been more active and with more years of experience would be a more informed source and that their responses would be more consistent as a group than those with less experience. In a small number of cases, respondents did not provide data for one or both of these two questions. Their responses were excluded from subsequent analysis using these questions.

The completed survey forms were characterized by the following occupation and IPO activity attributes.

Occupation	Surveys returned	Up to 3 years IPO Experience	Over 3 years IPO experience	Active in up to 3 IPOs	Active in over 3 IPOs
Advisor/Consultant	6	3	3	2	3
Corporate Executive	17	10	6	13	3
Investment Banker	13	2	11	5	8
Stock Broker	1	0	1	0	1
Venture Capitalist	54	18	31	31	20
Not provided	2	0	1	1	0
Total	93	33	53	52	35

The respondents were split into two reasonably sized groups within each activity indicator in order to test differences resulting from activity levels. Thus one set of analysis was undertaken with “years of IPO experience” as the underlying variable. This resulted in one group with “up to 3 years IPO experience” and one with “over 3 years”. A similar split was done with “level of IPO activity” with one group “active in up to 3 IPOs” and the balance in a group “active in more than 3 IPOs”. However no statistically significant differences in the weighting of attributes were able to be detected using these groupings.

It was expected that a reasonably high degree of support would be found for all items given the extensive interviews and clarification that was undertaken in developing the list. Due to the limited number of surveys returned it was decided to undertake the analysis by polarizing the responses into two groups: “Not Important and Marginally Important” as one group and “Important and Very Important” as the second group. A good proportion had reasonably high scores on level of “importance”. Twenty six items achieved “Important” scores of 75% or higher across all respondents. These are set out in Appendix One. In the following lists and in the appendices the item is identified by a code followed by a number which represents the percentage of respondents that scored the item in that category of importance.

However 9 attributes scored 40% or less on importance indicating that a large portion of the respondents did not believe that they contributed much to a successful IPO or to after market performance. This was something of a surprise given the source of the original list. These items are set out in Appendix Two. The remaining 10 attributes were ranked neither important nor unimportant consistently across respondents.

A small number of items were ranked Very Important across a large number of respondents. Items ranked as “Very Important” across all Occupation categories were as follows:

A3	98	Key shareholders agree to a public listing funding strategy
D14	98	CEO/CFO can articulate the business concept in non-technical terms
D9	98	Management team has significant relevant industry experience
D1	95	Financial reporting provides monthly monitoring of the business
A1	94	Directors agree to a public listing funding strategy
M11	92	The product/market offering has sustainable competitive advantages
D15	90	Management has the capacity to prepare and launch a public listing
M5	88	Business model predicts continued profitability

Four items relate directly to the IPO process itself while the remaining four describe elements of a successful business model.

At the other end of the scale those items which were ranked ‘Not Important’ across all respondents were:

M12	68	Products have endorsement of name brand global corporations
M10	64	Industry sector has appeal to international investors
M1	61	Revenue is at a minimum of $20 million
M18	46	The firm has representation in foreign markets where funding is sought

Three of these relate to a possible international dimension to the business. Clearly this is not seen to be of any great importance. The level of revenue however is an interesting result although perhaps attention is better directed at the possible capitalization (item M4).

One result which can be highlighted is that 16 of the top 26 Important items (Appendix 1) relate to the IPO process itself. There is considerable support for having the right parties involved in the process. This includes all the professional advisors such as accountants, lawyers, stock broker, underwriter and public listing advisor (items D5, D6, D2, D3, D4). It would seem that having knowledgeable and reputable advisors with relevant industry experience is a key part of the IPO strategy.

Of similar importance is an understanding the IPO process itself, being able to understand the needs of retail and institutional investors and being able to clearly articulate the business case (items D14, M16, D17, D15, M7, A2, M8). This is also emphasized in the importance of industry and public company experience of the management team and the Board of Directors (items D9, D10, D12, D13). Preparation for the IPO process is the other main set of attributes which are seen as important (items D15, D18, D19, D16).

Of the top 26 items, those attributes that relate to the underlying business model are very few (items D1, M11, M5, M21,). This tends to suggest that, while many firms may be able to demonstrate earning growth, an understanding of the IPO process itself is critical if the business is to launch an effective IPO strategy.

It was anticipated that there would be some difference in opinion based on occupation. Corporate executives, for example, that have been actively involved in an IPO experience might think differently from advisors, venture capitalists or investment bankers about what was important to the success of their IPO process. Although there was limited data to undertake this analysis, no appreciable differences were able to be detected between different classifications of occupations although perhaps the small size of the survey was insufficient to bring those out.

The additional comments provided by the respondents only provided one clear attribute that was missing from the survey. Multiple respondents included comments about the “quality of the management team”; however the comments provided did not provide an adequate description of what “quality” was defined as.

PRIOR LITERATURE SUPPORT

The criteria suggested by Golis (2002, P. 47) and Gladstone ( 2002, p. 312) are not well supported. There does not seem to be any strong support in the results of any specific level of revenue, profit or growth. Golis did however link IPO success to institutional support which was confirmed by the survey results.

There was not a lot of support for pre-IPO profit in the survey results although Yi found a relationship between pre-IPO profits and after market performance (Yi, 2001). The importance of the underwriter was put forward by Johnson (1988) and Chemmanur (1994). The survey results certainly supported the importance of the choice of underwriter alongside other professional advisors. The selection of investment bank is also supported by the work of Jain and Kini (1999a)(1999b) and Cater and Manaster (1990). The results also support the selection of the accounting/auditing firm as found by Titman and Trueman, (1986). Choice of underwriter was confirmed through the survey results. This confirms the work of Carter (1990)(1992). No mention was made of the importance of a HRM executive in the management team as being important to the preparation of the firm for the IPO success. While this does not negate the contribution of Welbourne, it also does not support their finding (1999).
CONCLUDING REMARKS

There is little in the prior literature to help a firm decide if it is a good candidate for an IPO, although it is difficult even from these survey results to pin down the size and scope of the business pre-IPO that would be a useful indicator. The best information that comes out of this survey is the potential of the business to achieve $100 million capitalization within 10 years (item M4), although perhaps that is predicated on having a robust business model with the right management team and a strong competitive advantage.

There is an overriding emphasis in the survey results on understanding the IPO process and having the right preparation internally and externally for the activity. This includes the right people in the management team and on the Board of Directors as well as the right selection of industry knowledgeable and respected advisors.

The aim of this research project was to try to provide some direction to firms in the pre-IPO period as to how they should best structure and prepare themselves for an IPO. To that extent it has certainly uncovered some useful information. However the number of completed surveys is inadequate to draw strong conclusions but it does open up a range of possible future research directions. There needs to be more investigation of the relationship between successful IPOs and the firm characteristics in the period leading up to the IPO event. Unless it is to be accepted that the IPO itself is a matter of chance, firms need to understand how they can better prepare themselves from a management and structural aspect to provide them with a better platform to launch a public funding strategy. It would also be useful to research the difference between firms that continue with an IPO compared to those that withdraw and the reasons for withdrawal. Are firms that withdraw less prepared for an IPO? If so, in what way were they less prepared? What attributes do firms display that successfully launch during weak IPO periods compared to those that withdraw?

There is some concern that the IPO process has been dominated by buyback and turnaround activity from the private equity sector. This provides little comfort for the new venture entrepreneur or the early stage venture capital fund or angel that would like to prepare a firm for an IPO. Further research needs to be undertaken on start-up ventures that made it successfully to an IPO to ascertain what attributes they displayed prior to their IPO activity. Is it possible to find common characteristics among these firms that would better help entrepreneurs structure their businesses for an IPO?

APPENDICES

Appendix One:

Items that scored 75% or above on “Important” and “Very Important”

A3	98	Key shareholders agree to a public listing funding strategy
D9	98	Management team has significant relevant industry experience
D14	98	CEO/CFO can articulate the business concept in non-technical terms
D1	95	Financial reporting provides monthly monitoring of the business
M16	95	Sufficient free float of shares is available to create liquidity in the market
A1	94	Directors agree to a public listing funding strategy
D10	94	Board of Directors has public company experience
D12	94	Board of Directors has industry knowledgeable members
M11	92	The product/market offering has sustainable competitive advantages
D17	91	Management understand institutional and public investor requirements
D5	90	Industry knowledgeable stock broker appointed
D15	90	Management has the capacity to prepare and launch a public listing
D18	90	Internal due diligence is undertaken as part of a public listing strategy
M7	89	industry sector has appeal to institutional investors
D6	88	Industry knowledgeable underwriter/book builder appointed
M5	88	Business model predicts continued profitability
D19	87	Internal controls/governance activities are reviewed as part of a public listing strategy
A2	86	Senior managers agree to a public listing funding strategy
D2	86	Industry knowledgeable and respected accountants are appointed
D16	85	The firm can afford the costs of a terminated/delayed listing
M8	84	Industry sector has appeal to retail investors
M21	83	Revenue growth and risk minimisation is anticipated through continued product releases and geographic expansion
D3	81	Industry knowledgeable and respected accountants are appointed
D4	81	Industry knowledgeable public listing advisor appointed
D13	81	Board of Directors has reputable public company experience
M4	75	Expected market capitalisation will exceed $100 million in 10 years

Appendix Two:

Items that scored 40% or above on ‘”not important” and “marginally important”

M12	68	Products have endorsement on name brand global corporations
M23	66	Technology status is supported by creditable international authorities (if applicable)
M10	64	Industry sector has appeal to international investors
M14	59	Post IPO no shareholder holds more than 30% ownership
M9	50	The firm has national appeal
M7	47	Revenue resilience is shown through multiple diversified product offerings
M18	46	The firm has representation in foreign markets where funding is sought
M15	41	Post IPO external shareholders hold more than 40% ownership
D8	40	Senior financial management has IPO listing experience

Appendix Three:

Items that were somewhat evenly balanced. Score shown below is for “Important” and “Very Important”

M20	72	Revenue growth and risk minimization is anticipated through continued product releases or geographic expansion
M22	72	Technology status is supported by creditable international authorities (if applicable)
D7	70	Senior management has public company experience
M13	68	Funds raised will be used for revenue growth
M17	67	The firm has strategic alliances and acquisition strategy to build growth and resilience
M19	66	The firm has been profitable for at least a year
M2	65	Expected revenue within 10 years exceeds $100 million
M3	62	Market capitalization is at least $50 million on listing
M1	61	Revenue is at a minimum of $20 million
D11	60	Board of Directors has a majority of independent Directors

REFERENCES

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IPO Exit Strategies: Lessons from the Biotechnology Sector

Daniel — Fri, 08 May 2009 05:54:15 +0000

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Presented at ANZAM 2003 Fremantle, Western Australia
By Tom Mckaskill

Abstract

Founders and private equity investors need to have an exit strategy to liquidate their shares in a new venture. Most often this is achieved through an outright sale to another corporation or through an initial listing on the stock exchange, an Initial Public offering (IPO). Over the last few years, the biotechnology sector experienced a boom that resulted in many new companies being listed. However, with the collapse in the market, many of these have failed to provide the exit objectives of the investors and have failed to achieve the levels of funding needed for product research to bring new products to revenue generation. With tighter listing rules many of these companies would not have been able to list.

Keywords: exit strategies, IPO, exit ready, commercialisation, entrepreneurship

Introduction

Entrepreneurial ventures in the high technology sectors typically involve the commercialisation of intellectual property, the potential of global markets and short windows of opportunity. Founders normally require financing beyond their personal resources and seek private equity capital from angels and/or venture capital firms. Most often the founders and the venture capitalist see the public market as the ultimate goal. They see the IPO as the means to exit the private equity holders, provide them with growth capital and provide the founders with a vehicle where they can liquidate part or all of their investment.

Few start up firms however will ever be listed on a public exchange. Even venture capital backed firms have a low probability of being listed. Golis shows that only 12% of all Australian VC backed firms were listed to the end of June 2002 (Golis, 2002: 235). However in boom or ‘hot’ markets the level of activity increases dramatically. Golis shows that, for VC backed firms, 7 of 17 exits in 1998/9 and 11 of 13 exits in 1999/2000 were floats.

Much of the IPO activity in 1999 to 2002 was in the biotechnology sector. This sector experienced a boom market (Intersuisse, 2003: 1). This resulted in many small, often inexperienced, biotechnology companies listing ((Deliotte, 2002: 39). However by early 2003 the market had declined by 40% and many of those firms were faced with a funding crisis. With the closure of the market to new initial public offerings (IPO) and no activity for successive rounds of funding, less resilient biotechnology firms were facing a lack of funds to complete necessary product development to enable them to reach profitability (Yakatan, 2003).

The market volatility in biotechnology has seen earlier parallels in other high tech markets with, often, many company failures. The questions that this raises are;

do the ASX rules need to be tightened so that firms need to be more robust before they can list
how do we measure robustness or resilience in a pre-IPO venture

Background

Like other sectors before it, enterprise resource planning (ERP), supply chain optimisation, and the internet, the biotechnology capital markets went through a boom between early 1999 and 2002. The market rose 760 percent during the 3 years up to its peak in February 2002 and then fell 30% 10 months later (Intersuisse, 2003: 3). The amount of follow on capital raised in the USA during in Q3 2002 was down 36% and capital raised by medical device firms fell from A$5.5 billion in Q1 FY2002 to only A$643 million one year later (PWC, 2003, p2). Australian biotechnology sector had a similar decline falling 36% during the period 2001-2 (Intersuisse, 2003: 6)

Biotechnology IPO activity has dried up along with every other sector. No IPO activity occurred in the USA or Australia during Q1 2003 (PWC, 2003: 2). Not only had the biotechnology burst, the entire public market was frozen.

Biotechnology companies generally need significant public financing to see them through the development phases of their commercialisation processes. Many of the 60 Australian Stock Exchange (ASX) listed companies had used IPO funding to assist them to progress their early stage discoveries. The money was used for a variety of purposes from drug development, pre-clinical trials to early phase clinical trials. However most had undertaken the IPO with the view that subsequent public fund raising would see them through to revenue generating products. With the collapse of the biotechnology boom and the freezing of the public markets generally, the prior levels of public funding and the high valuations are unlikely to return.

The lucky firms that went to the market early in the boom and had the opportunity of a subsequent round, either domestically or overseas, may well have built up a sufficient cash reserve to take them to profitability or at least to the development stage where licensing or sale is a real possibility. Later entrants may not be so fortunate. An early IPO may not have raised significant funds, perhaps AUD$5 – 30 million. With high burn rates this may not see them to revenue generation. Their alternatives at this point are bleak. They may be forced into a fire sale, they may have to sell off assets or they may be forced to sell R&D achievements at a heavily discounted price to survive (PWC, 2003: 20).

The firms that came to market just before the biotechnology crash may not have had sufficient liquidity or after market support to maintain a price higher than their listing price. Where this declined in the first 12 months following the IPO, investors locked up in escrow may not have seen a positive return on their investment, or may not be able to exit without a substantial loss, thus locking them in for some unknown period. At the same time the retail investor may well have suffered with the collapse of the weaker firms. Five firms recently had market capitalisation below net assets (Intersuisse, 2003: 1).

At the same time, lack of cash reserves may be damaging to commercialisation progress. R&D may well have to be scaled back, trials delayed, and development opportunities lost. As at September 2002, smaller firms had an average of only 18 months funding (Intersuisse, 2003: 1). Many of the larger IPOs that were expected in the early part of 2003 have been cancelled or delayed due to market conditions (PWC, 2003: 17).

The public market has become very risk adverse with the decline in the market. The decline was associated with fewer FDA approvals, unfavourable clinical trials, and negative news (PWC, 2003, pp3-8),. Future public market fund raising efforts by biotechnology firms may experience much higher hurdles in terms of development progress, existing revenue achievement and established alliances. In the medical devices sector, alpha testing may well be a condition of even venture capital investment. Since venture capital has been the primary source of funding for early stage companies, (AusBiotech, Vol 13 No 1: 28), this may well hinder the start up rate of biotechnology firms in the near future.

The PWC BioForum concluded that “Suffice to say companies and investors remain cautious about IPO as a viable exit strategy” (2003: 22). The report concludes that “ Australia needs the formation of larger companies with R&D pipelines, preferably with at least half their products in or near clinical trial and better trained personnel. These companies will be more attractive candidates both in Australia and on a global level” (2003: 28).

Implications for Exit Strategies and the IPO Process

The biotechnology market boom allowed many companies to go to an IPO where in normal times may not have gained the support of the advisor, underwriter or the institutional investors. While some were lucky, the long term costs to the community may well offset these early gains. Longer term implications include:

Inability for good firms to find angel and VC funding
Lack of interest from institutional investors
Brokerage and underwriters being unwilling to support a transaction
Public investors being unwilling to invest
Lack of liquidity in the public market depressing the share price (Gompers and Lerner, 2001: 220).
Inability of existing firms to raise additional funds

Of the 60 ASX listed biotechnology firms, over half were listed between 1999 and 2000 (Intersuisse, 2003: 2). ‘Boom’ markets can create market conditions which are not healthy for the founders nor the VC firms. The self-liquidating structure of the VC funds, for example, can also prompt venture capital organizations to rush young firms to an IPO in order to demonstrate a successful track record – even if the investees aren’t ready to go public (Gompers and Lerner, 2001: 99).

VC firms typically exit some period after the IPO, often after a period of 12 months. Of the 59 firms tracked by the Intersuisse Biotechnology Index 23 had falls during 2002 of over 50%, 18 dropped more than 30%. In the same period the ASX All ordinaries index fell by 11% ( 2003: 3). Five ASX listed firms recently had market capitalization below net assets ( 2003: 1). Some VC firms with more recent IPO’s may well have failed to recover their investments in this period. Founders are however typically tied in for longer periods. While they may be able to liquidate some equity, markets are uneasy when founders liquidate substantial holdings. In a declining market, there is also the possibility of ‘insider trading’ claims which may cause founders to hold onto stock.

Where private equity investors have been ‘locked in’ through escrow arrangements, they may be unprepared to go back into a sector which they regard as volatile. Where they cannot see a real possibility of a successful exit due to a volatile market, they may be unprepared to invest (Martin,1997: 71), (Gladstone and Gladstone, 2002: 93). Successful exits are not only important for remuneration of the VC partners, they impact the VC firm’s ability to raise additional funds (Lerner, Josh 2000: 369).

The timing of an IPO is often dependent on conditions outside the company’s control, such as general market receptivity to IPOs at the time; whether the relevant industry is ‘hot’; whether major institutional investors have exceeded their proportion of their portfolios reserved for investment in the relevant industry; and whether there has been an announcement of disappointing financial or regulatory results by a competitor in the industry that causes the market to be wary of the industry as a whole.(Bagley and Dauchy, 1999: 408).

Finally, it may well be that taking a firm public is the preferred choice for many when the IPO markets are booming however, these markets are unpredictable even for the best IPO candidates (Petty, 1996: 437-8).

Boom markets can create situations where firms are able to undertake an IPO. However due to the unpredictability of boom markets, this may not achieve the successful exit required by the VC firms and the founders. Public listings in ‘cold’ markets tend to be of higher quality and are much more likely to do better over the long term (Seligman, 2003: P50).
Development of an IPO Ready Index

The IPO is seen by many VC firms as the ideal exit route for their investment, Generally speaking they can achieve a higher ROI in an IPO than in a trade sale (Wang and Sim, 2001: 347). Golis quotes an IRR of 29 percent for an IPO versus 9.5 percent IRR for a trade sale ( 2002: 342). Thus much of their effort during their investment period is consumed with creating the right attributes within the investee firm that would allow them to take it to an IPO. A boom market seems ideal for the VC firm as the likelihood of taking a firm to an IPO is greatly improved. However, do firms that take advantage of a boom market actually deliver the long term benefits to the VC firm, to the founders and to their shareholders?

In order to undertake some tests of the impact of boom markets on exit success, the Author worked with several VC firms and merchant banks to develop a list of ‘desirable attributes’ of firms seeking an IPO event. These firms established a list of desirable outcomes of the IPO. These were:

The level of funds sought to be raised by the IPO was readily achieved without having to offer a substantial discount to the institutional investors
The after market price was maintained or increased over several years following the IPO (relative to the general movement in the market)
The firm was able to raise additional funds on the public market at a price above the price of each prior round
The firm achieved sustainable profitable growth within several years of the IPO
The reputation of the bank with institutional investors was not damaged by the performance of the firm over several years following the IPO

These objectives seem to be achieved, at a minimum, if the capitalization of the firm over several years subsequent to the IPO is at least equal to the capitalization of the firm at the time of the IPO. For example, Intersuisse reported that, even with the decline in the biotechnology market, seven firms had price increases in 2002, six others were unchanged or fell less than 10% (2003: 3).

As a group, did the firms that were able to maintain or improve their capitalization value in a declining market demonstrate different attributes at the time of their IPO? If this is the case and such a list could be generalized across other sectors, it is possible then to use this information to assist VC firms and merchant banks to better select candidates for an IPO path.

The proposition was put to these firms in the following form:

In reviewing possible candidates for a possible IPO, what are the attributes that you look for given that you wish to achieve the objectives identified above?

Each attribute could be graded in terms of a level of achievement on a scale of 1 – 5 in the following form.

Level of Attainment

Nothing done	Little progress	Reasonable progress	Significat progress	Fully attained
1	2	3	4	5

This scale has also been proposed by McKaskill, Weaver and Dickson (2003) for use in measuring the quality of a trade sale exit strategy. The proposed IPO Ready Index is set out in Appendix A. Scoring of the Index would be undertaken by the listing agency.

This suggests several possible hypotheses:

Firms that score higher on the IPO Ready Index are able to sustain higher capitalization values post IPO relative to their IPO capitalization value
Firms that score very low on the IPO Ready Index are more likely to have capitalization values less than net assets subsequent to a major decline in the sector market values
Firms that were taken to an IPO during the boom period are more likely to have lower IPO Ready Scores than firms with an IPO prior to the boom period
Firms with low IPO Ready Scores are more likely to be acquired in a period following a rapid decline in the sector market values

Boom Market Conditions

The Biotechnology sector outperformed the overall market over the period July 1999 to January 2003 (Intersuisse 200: 3). For a good portion of that period, it was double the ASX All Ordinaries Index.

To identify the underlying factors of the ‘hot’ market, the Author interviewed several of the Directors of Intersuisse and a Vice President of Duetsche Bank in Melbourne (Buckley, 2003), (O’Brien, 2003). The Author had also been an active CEO in the 80’s during the Enterprise Resource Planning (ERP) software boom, an active CEO in the supply chain optimization (SCM) software boom in the mid 90’s and a founder of an internet company during the internet boom in the late 90’s. The consensus of these meetings is as follows;

A hot public market is normally created when the following circumstances coincide:

Economic conditions globally are positive
There is a breakthrough technology which can spawn major benefits
The benefits are readily understood by the institutional and public investors
The new technology is able to support many different applications
The breakthrough technology is readily available to emerging firms
The early emerging firms demonstrate very high potential revenues
Emerging products have a global market of substantial size
The emerging products solve complex problems which hitherto were not able to be readily solved

The hot public market collapses when the following occurs:

Global economic conditions significantly slow down
The most prominent firms in the emerging sector fail to meet significant targets or milestones
A prominent firm is found to have breached compliance regulations in a significant manner

These attributes of the hot market need to be verified but are supported by the Author’s experience over several boom markets. The ERP boom was created by the dramatic increase in computing power, the larger computer memories and the emerging network architecture. The SCM boom was made possible by significant increase in PC memory and the client server architecture. The Internet boom was created by advances in internet technology and major increases in internet band width. The Biotechnology boom was created by the human genome project.

However hot markets are hard to predict. The interviewees from Intersuisse and Duetsche Bank maintained that hot markets can close at any time. While many VC firms were taking advantage of the hot market being open, they argued that many companies would have lost considerable money in IPO preparation when the market collapsed as they would not have been able to go to an IPO in a normal market. Given that most IPOs take from 3 – 12 months to prepare, few market professionals are prepared to guarantee that a hot market will be open at the end of the preparation period.

Johnathan Buckley of Intersuisse maintains that the only firms that demonstrate ‘enduring qualities’ should be prepared for an IPO (Buckley, 2003). His argument was that hot market conditions were unpredictable and that the only firms that could sustain themselves over longer periods could provide an adequate return to investors. The list of enduring quality attributes that were generated over several meetings with Buckley and O’Brien are included within the IPO Ready Index.

As can be seen, this list is quite extensive and covers areas of financial performance and expectations, due diligence and governance and strategy. The only other reference to such a list of attributes is provided by Chris Golis, currently Executive Chairman of the Sydney based Nanyang Management, a VC firm. Golis lists the following attributes;

Valuation of at least $20 million
Support of the institutional investors such as insurance companies and pension funds where a $1 million investment would result in less than 5% ownership
Profit after tax of $1.5 -$2 million for the year preceding the float
Prospective forecast of profit after tax of $2-$3 million (2002: 47)

These attributes set hurdle rates higher than the current ASX listing requirements (ASX, 2003).
Research Methodology

In order to test the hypothesis outlined some preliminary work will be required. Included in this work will be the following:

Refinement of the IPO Ready Index

The Index as shown in Appendix A, is an initial list of attributes. This will be circulated to a number of VC firms that have been active in IPO exits. In addition, additional merchant banks and brokers will be asked to evaluate the list. This exercise will identify additional items, withdraw items that are not seen as important and help improve the wording to remove any unclear interpretations

Pilot Test of the IPO Ready Index

The IPO Ready Index will then be trialed with several biotechnology companies that have undertaken IPOs over the last few years. The listing agency, VC firm or advisor will score the firm at the time prior to the IPO launch. This will then be compared to the subsequent market performance of the firm to see if the hypotheses are likely to be supported.

Selection of firms to be tested

It is proposed to select the biotechnology firms that listed on the ASX between 1990 and 2002. A list of firms is contained in the Intersuisse Monitor (Intersuisse, 2003 p16). This list includes the three major firms, Cochlear, CSL and ResMed as well as 6 firms with a market capitalization of less than $10 million.

Hot Market definition

For the purposes of this study the boom market in biotechnology will be taken as September 1999 to December 2002.

Since the study requires a period of, say, two years beyond the end of the boom period, the data collection and analysis will not be able to be undertaken until the end of 2004.
Additional Research Areas

Boom conditions occurred in other sectors (ERP, SCM and Internet). It would be possible to conduct a similar study for these sectors. Given that these booms occurred some years back, the post boom data would be available to test the hypothesis.

Conclusions

Clearly hot markets create conditions which have unpredictable outcomes for investors. Many VC firms lost money when the internet bubble burst. It is anticipated that the same result will occur with the shake out for the biotechnology sector. This leads to speculation as to whether this outcome would have occurred if the stock exchange had imposed higher requirements (higher IPO Ready Scores) on firms wishing to undertake an IPO. There is a growing body of opinion in Australia that the ASX should develop a code of reporting standards and guidelines similar to that used in the mining industry (Green, 2003: P23). While this may have informed investors better, it would not have avoided the situation where less viable firms should have been discouraged from taking the IPO route to funding.

The current listing requirements allow quite small companies to list (ASX, 2003). With tougher listing requirements, fewer emerging companies would have been able to use an IPO event as a possible exit path for the private equity holders. Fund raising would then only have been achieved through further rounds of VC finance or through equity injections from industry partners (Green, 2003: 23). At the same time, more firms would have considered consolidation in order to meet IPO requirements (Blake and Pachacz, 2003: 44). This perhaps would have resulted in more enduring firms with fewer disappointments to public and institutional investors. Yakatan strongly recommended higher hurdles for listing and said more emphasis should be put on consolidation within the sector to achieve more sustainable businesses (2003).

With tighter listing requirements, more early stage firms would have taken a trade sale exit route, possibly resulting in better returns to the VC firms, thus avoiding the current poor after market situation.

References

AusBiotech, Vol 13, No 1, 2003, ‘Growing Australasian Biotechnology through improved access to people and capital’ in Australasian Biotechnology, AusBiotech, Melbourne
Australian Stock Exchange listing rules http://www.asx.com.au/ListingRules/chapters/ch01.pdf Accessed 2/5/03(ASX)
Bagley, Constance and Dauchy, Craig “Going Public” in Sahlman, William, A., Stevenson, Howard, H, Roberts, Michael J The Entrepreneurial Venture 2 nd Ed. Harvard Business School Press,1999
Blake, D., and Pachacz, M. “Take your Partners” in BRW April 3-9, 2003
Buckley, Jonathan, Director Intersuisse Corporate, Melbourne, interviewed 26/3/03
Deloitte Touche Tohmatsu, 2002, in Australiasian Biotechnology Vol. 12 No. 4 August/September 2002
Gladstone, David and Gladstone, Laura, 2002, Venture Capital Handbook – An Entrepreneurs Guide to Raising Venture Capital, Financial Times Prentice Hall
Green, G., 2003, “Biotech Industry Faces Crucial Issues” in Australiasian Biotechnology Vol. 12 No. 6 December 2002/January 2003
Gompers Paul A. and Lerner Josh, 2001, The Money of Invention- How Venture Capital Creates Wealth Harvard Business School Press, Boston
Golis, C., 2002, Enterprise and Venture Capital – a business builder’s and investor’s handbook, 4 th Ed, Allen & Unwin, Sydney
Intersuisse, September 2003, Emerging technology Monitor: Biotechnology Issue, Intersuisse Limited, Melbourne
Lerner, Josh 2000, Venture Capital and Private Equity – A Casebook, John Wiley & Sons
Martin, B , 1997, Informal Equity Investment , Commonwealth of Australia Small Business Research Program – Information Paper, (Prepared by Barbara Martin) April 1997
McKaskill, T, Weaver, K. M., and Dickson P, 2003, “Proactive Exit Strategy – Does it make a difference?” to be presented at the ICSB Conference, Belfast, June 2003
O’Brien, Andrew, Director M&A, Deutsche Bank Australia, Melbourne, interviewed 14/4/03
Petty, William, Chapter 14, in Bygrave, William D. (Ed.), 1996, The Portable MBA in Entrepreneurship 2nd Ed. John Wiley & Sons
PriceWaterhouseCoopers, January 2003, Bioforum, Corporate Finance and Advisory, PriceWaterhouseCopers, Sydney (PWC)
Seligman, D., 2003, Forbes Global, March 31 st, 2003, pp50-51
Wang, C. K., Sim, V. Y. L., 2001, “Exit Strategies of Venture Capital-backed Companies in Singapore” in Venture Capital, Vol. 3, No. 4, pp337-358
Yakatan, Stan, Chairman of Biocomm Services Pty Ltd and Biotechnology Advisor to the Sate of Victoria, interview 3/4/2003, Melbourne

Appendix A: IPO Ready Index

Each attribute is graded in terms of a level of achievement on a scale of 1 – 5 in the following form.

Level of Attainment

Nothing done	Little progress	Reasonable progress	Significat progress	Fully attained
1	2	3	4	5

Alignment Activities

Directors agree to a public listing funding strategy

Senior managers agree to a public listing funding strategy

Key shareholders agree to a public listing funding strategy

Due Diligence/Governance Activities

Financial reporting provides monthly monitoring of the business

Industry knowledgeable and respected accountants are appointed

Industry knowledgeable and respected lawyers are appointed

Industry knowledgeable public listing advisor appointed

Industry knowledge broker appointed

Industry knowledge underwriter appointed

Senior management has public company experience

Senior financial management has IPO listing experience

Management team has significant relevant industry experience

Board of Directors has public company experience

Board of Directors has a majority of independent members

Board of Directors has industry knowledgeable members

Board of Directors has reputable public company experience

CEO/CFO can articulate the business concept in non-technical terms

Firm has existing funding which could cover next two years

Management has the capacity to prepare and launch a public listing

The firm can afford the costs of a terminated/delayed listing

Management understand institutional and public investor requirements

Enduring Market Requirements

Revenue is at a minimum of $20 million

Expected revenue within 10 years exceeds $100 million

The firm has been profitable for at least a year

Business model predicts continued profitability

Revenue growth is anticipated through continued product releases

Revenue resilience is shown through multiple diversified product offerings

Risk minimisation shows early and later product developments

Industry sector has appeal to institutional investors

Industry sector has appeal to the general public investor

The firm has national appeal

Industry sector has appeal to international investors

The product/market offering has sustainable competitive advantage

Products have endorsement of name brand global corporations

Technology status is supported by creditable international authorities

Funds raised will be used for revenue growth

Post IPO no shareholder holds more than 30% ownership

Post IPO external shareholders hold more than 40% ownership

Post IPO market capitalisation will exceed $50 million

Sufficient stock (free float) available to create liquidity in the overseas market
Funding strategy involves multiple public funding rounds
The firm has strategic alliances and acquisition strategy to build growth and resilience

The firm has representation in foreign markets where funding is sought

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The Next Generation of Venture Capital: Hot Ideas from Sand Hill Road

Daniel — Sun, 03 May 2009 20:30:23 +0000

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Great video from the Milken Institute Global Conference 2009

Speakers:

Alec Ellison, Co-Head of Investment Banking; Chairman, Technology, Media and Telecom Group, Jefferies & Company Inc.

Steve Jurvetson, Managing Director, Draper Fisher Jurvetson

Eric McAfee, Chairman, McAfee Capital

Ford Tamer, Operating Partner, Khosla Ventures
Moderator:

Kara Swisher, Co-Executive Editor, All Things Digital

see the video here

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Investors Invest in Management

Daniel — Tue, 14 Apr 2009 16:13:55 +0000

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Column by Michael Lechter Inc.com

Investors Invest in Management

The team you have in place will figure prominently in an investor’s decision to fund your business.

One factor that almost always figures into a savvy potential investor’s evaluation of your company is your “team” — key management and advisers. This is particularly true for a young company with no track record of its own.

Why do investors tend to base their decisions to invest on management teams? The answer is in large part because there are so many imponderables about any emerging business. Even a great business idea sometimes simply can’t succeed on its own strength alone. The idea may be too revolutionary, too unproven or otherwise lack sufficient credibility. It may involve a product or technology that is simply too complex for the potential investor to understand, or market projections that are simply too speculative. This is when you have to rely on the management team to give the business credibility. The history of the management team may be the only solid, understandable, non-speculative information available to the potential investor.

Investors tend to look closely at the experience and track record of the management team. A business must be able to succeed in the face of rapidly changing conditions. Relevant experience gives the potential investor comfort that the management can spot the issues and challenges and are flexible, skilled and objective enough to be able to deal with those conditions.

Of course, what really counts is experience that’s relevant to the specific needs of the company. For example, experience in a Fortune 100 company may not be particularly pertinent to running a start-up. In fact a common perception is that someone whose experience is entirely from big companies will tend to throw money at a problem, and may not be sufficiently flexible to deal with a small-company environment where inexpensive alternatives are necessary. It is also important that the experience be in the relevant industry. Experience in the lingerie industry may not be particularly germane to a software development company.

However, experience, skill and pedigree are not the only factors that investors look for. Integrity and commitment are also typically a must. Investors want to see a high level of work ethic on the part of management. They need to feel comfortable that all of the key players are committed to, and have enthusiasm for, the company. (For example, many investors consider it important that the key individuals involved in management have “skin in the game,” i.e., have themselves invested in the company).

The wrong management team can be deadly to potential investor interest. You can have the greatest technology in the world or the best marketing plan, but if your management team cannot execute the business plan, or if they alienate the customers, or cannot hire and manage good people, then the business likely will fail.

Charisma in a management team is good, but too much can get in the way. Savvy investors want key players to have egos that are big enough to get the job done, but not so big that the individual can’t be a team player or can’t accept advice. A sophisticated investor often looks for investments in industries in which the investor has relevant background and expertise — and expects to be able to contribute his or her expertise to the venture. If the investor perceives the management as too arrogant or egocentric to accept advice, prospects of the investment being made are minimal.

“Guerrilla” management that is perceived as likely to ignore professional advice (e.g., from attorneys and accountants) also tends to be problematic for investors. In the book OPM, I introduced a hypothetical character called Louis (Loose) Canon, whose mantra is, “I’m not going to let those attorneys and accountants run my company!” Sophisticated investors tend to run away from the Louis Canons of the world, and unless the company’s team includes (or the investor is able to place) other key individuals with sufficiently strong personalities in positions with sufficient clout to counterbalance and keep the “Loose Cannon” in check, the company’s prospects are dim.

Another pertinent factor is the “completeness” of the team. Do you have, or is there a plan to place, a strong individual in all of the important positions? But what makes an individual “strong” or a position “important”? That depends upon the nature and stage of development of your business. The definitions of “strong” and “important” positions are moving targets. The team necessary for a start-up seeking only that funding or resources necessary to establish “proof of principle” for a product might require no one other than the person that came up with the idea. However, as a business develops and grows, so do the positions that are critical to management. These can ultimately include the functions of chief executive officer (CEO), a chief financial officer (CFO), a chief technology officer (VP of Engineering, Chief Information Officer (CIO)), and a director of sales and marketing. (Of course, sometimes a single individual can fill more than one role.)

In a nutshell, potential investors want to know that they can trust you and your team with their money. They want to feel secure that you and your team will succeed in the business and will protect their interests. Your job is to put together a team that will give potential investors that confidence.

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Venture capital challenges

Daniel — Sun, 12 Apr 2009 16:43:37 +0000

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India and China aren’t just attracting entrepreneurs who are returning from overseas, but also venture capitalists. At a recent Quality of Management panel discussion at INSEAD’s Asia campus in Singapore, Chan Tze Hoe, investment manager with CAP Vista in Singapore, said that as markets grow in both countries, people who were born there but then educated in the West are “coming back to join the scene.”

He noted that Asia is seeing a transition to venture capital-backed businesses from home-grown ones. Speaking about the regulatory framework and environment for venture capital, he said that while this is well developed in the the US and Europe, it has only emerged in the past ten years in India and China.
Understand the culture

Chan said that, regarding China, it’s important to understand the culture and build up a network: “A VC fund, previously based in London, was trying to set up a China office. They’ve actually set up their presence there for two years but haven’t invested in a single deal … They told me they are taking a watch-and-see attitude. When you want to start up a business in China, you really need to build up your contacts and find someone who is familiar with the environment to partner with you to achieve some sort of success.”

Chan says that most of the active investors have been in China for some time: “You probably need a lot of local knowledge (in terms of business culture, local language, deal sources, regulatory framework and government/industry networks) to source … deals that are not only right … but also where the business can grow or lead even with potentially undiscovered limitations/conditions. It is unlike Silicon Valley where the industry is well developed and structured so that information generally flows quite quickly among the few top VC shops.”

Chan told Knowledge: “China, in my opinion, is building up such a system of deal flows – not just in VC but also gradually in private equity … Having said that, I personally do not think one can force-fit Silicon Valley’s style of venture capital on the Chinese model, since investment success is very much driven by the people on the ground and when the cultures are different, rules have to be set differently.”
Taking a wait-and-see approach

Chan said that most foreign VCs are still adopting a wait-and-see attitude regarding China, although the advantage of having a local partner is that the initial deal sourcing process is generally accelerated: “The question is whether these foreign VCs can use the same business principles (investment culture/methodology, corporate governance practices) in the Chinese context.”

Phil Anderson, Professor of Entrepreneurship, who hosted the Quality of Management panel discussion, points out that many Western VCs are opening offices in China to help their portfolio companies – not to do deals as such – and these are taking time to learn about the region before raising funds to invest in mainland companies.
Geographical ‘nuances’

Another speaker at the Quality of Management session, Jayesh Parekh of Sony Entertainment Television and MobiApps, advises venture capitalists to spend a lot of time in India and China. He says he has VC friends who go to India twice a year but that’s “not sufficient to discover” that country. As for geographic location, “each one has a nuance.” The West and North of India, he says, are more entrepreneurial, while in the more risk averse South and East, you’ll find “a lot of loyalty and excellent skills, especially for technology, so it depends on what kind of start-up you want to do.”

However, he adds that companies are finding it difficult to attract talent with share options in places like Bangalore, as most people want to work “for a stable, major corporation that pays good salary and perks, rather than take the risk with start-ups. Hence share options do not really help in attracting good talent. Given a choice between more money or upside with share options, most professionals will chose cash.”
Private equity is ‘developing rapidly’

Parekh told Knowledge that venture capital firms in India are mostly interested in retail, real estate, information techology/business process outsourcing/call centre and services, rather than high-tech or intellectual property-related businesses. “I think the private equity (rather than VC) scene is developing rapidly in India. Both locals and foreigners are getting involved, and in some cases foreign VCs are partnering with locals as well. I think the time is excellent for VCs to go into India,” he says.

Harish Parameswar, Managing Director of financial advisory and asset management firm Lazard Asia, echoes Parekh’s views about private equity in India: “I would say you’ve seen a lot of private equity and buy-out firms come up in India but venture capital is relatively tough if you’re at an early stage, unless you have some Indian investors who are from (Silicon) Valley. It’s relatively difficult to get early stage financing.”
The Indian networking advantage

Parameswar told Knowledge that Indian venture capitalists have an edge over their Chinese counterparts in terms of networking in the United States: “If you look at the Silicon Valley Indians, they set up this organization called TiE (The Indus Entrepreneurs, also known as Talent Ideas and Enterprise). This is a very, very influential organization, which is primarily run by successful Indian entrepreneurs in Silicon Valley.” The organisation helps VCs meet prospective companies, Parameswar says. “I would say the Indians have had a bit of an advantage over Chinese companies on that front. It’s more organised, I would say.”

Silicon Valley companies have been looking at India as an outsourcing development centre, Parameswar says, with “almost every start-up in the Valley” having back-end offices in India. “So when it comes to technology development, because of language and skillsets, India seems to be the preferred option. But when it comes to manufacturing and production, China still has the edge on that front.”

He adds the biggest difference between Indian and Chinese VCs has been that many of the companies that were set up in India have been developing technologies for the global markets rather than for the domestic market. “In China the market has been pretty much geared to the domestic market and that’s been a huge, huge plus, because a lot of these companies are able to get revenue traction without having to spend as much money.”

Consequently, China has been able to attract a lot more venture capital than India, he says: “Because of the domestic market, (companies) have managed to scale much more rapidly and therefore venture capitalists exit much faster as well.”

Profiles

Chan Tze Hoe is an investment manager in Cap Vista who focuses on analysing and executing investments across various technology sectors. His professional interests include strategic investments, valuation and corporate strategy.

Prior to joining Cap Vista, he was a researcher with DSO National Laboratories and was involved in various multi-million dollar R&D projects at its Guided Systems Division.

CAP Vista, the venture investment arm of the Defence Science & Technology Agency in Singapore, aims to “identify and execute strategic investments in early-stage, high-tech companies to serve Singapore’s defence initiatives.”

Jayesh Parekh is a founder and director of MobiApps, a Singapore-based technology company and is also a founder and director of Sony Entertainment Television, a major cable & satellite television channel launched in collaboration with Sony Pictures Entertainment (Columbia/Tristar).

Prior to those ventures, he spent 13 years at IBM in various positions based out of Houston, Texas in USA and in Singapore, where he was involved in technical, sales and marketing roles. He is an angel investor, with investments in venture capital funds in Silicon Valley and India.

Harish Parameswar, Managing Director of Lazard Asia, has been overseeing the expansion of the firm’s Southeast Asia advisory business and also covers the technology and media sectors across Asia for Lazard. Before joining Lazard, he was the founder and Managing Director of Beacon Advisory, a boutique Asian advisory firm, and has also worked for Deutsche Bank and JPMorgan/Jardine Fleming in various corporate finance roles in Asia.

The views expressed in this article are the personal opinions of the individuals concerned and do not reflect those of their employers or their portfolio companies.

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VC Confidence Improving

Daniel — Thu, 09 Apr 2009 13:26:46 +0000

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I read this post in Sophisticated Finance by Bob Hacker, great signal that the economy is improving.

Venture capitalist confidence in the economy may be improving for the first time since 1st quarter 2007. As reported by Mark Cannice at the University of San Francisco:

“The quarterly Silicon Valley Venture Capitalist Confidence Index™ (Bloomberg ticker symbol:
USFSVVCI) is based on an on-going survey of San Francisco Bay Area/Silicon Valley venture capitalists. The Index measures and reports the opinions of professional venture capitalists in their estimation of the high-growth venture entrepreneurial environment in the San Francisco Bay Area over the next 6 – 18 months.The Silicon Valley Venture Capitalist Confidence Index for the first quarter of 2009, based on a March 2009 survey of 30 San Francisco Bay Area venture capitalists, registered 3.03 on a 5 point scale (with 5 indicating high confidence and 1 indicating low confidence). This quarter’s reading rose from the previous quarter’s reading of 2.77 (a 5 year low)..”

The historic chart is below.

Perhaps another small piece of evidence to suggest an upturn in the economy.

Note:I found this information through a tweet by @briannorgard.

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Why cleantech investor Vinod Khosla spreads his wealth all over the table

Daniel — Wed, 11 Mar 2009 00:56:15 +0000

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Khosla makes $500 million bet on cleantech

San Francisco Business Times – by Lindsay Riddell

Vinod Khosla is a betting man.

Khosla Ventures, the Menlo Park-based venture firm he formed in 2004, has invested more than $500 million of his own money, mostly in clean technology companies that fight climate change and oil dependence.

If it sounds daunting, Khosla suggests a better word: fun.

“The harder the problem, the more challenging it is and the more fun it is to try and do it,” he said. “The more unreasonable, the bigger the odds.”

Lowering those odds means spreading the bet. Khosla has invested in more than 30 cleantech companies. They include investments in ethanol and other biofuels companies; alternatives to coal; technologies to improve the energy efficiency of engines, homes, water systems, lighting and batteries; and companies working to make basic materials like plastics and cement that are less energy-intensive and better for the environment.

For the scale and scope of Khosla’s cleantech investments, the Business Times has named him Financial Dealmaker of he Year for 2008.

Khosla is one of the best-known, if not the best-known, cleantech investor in the Valley. He’s earned that reputation through straight talk, a deep grasp of specialized science and a strategy of taking as many “shots on goal” as he can to increase the likelihood that he funds winners.

“You do the right things, the small things, you take the right risks, and then you work like hell to turn possibility into likelihood,” Khosla said.

He is unfazed that weaning the world off coal or oil, or significantly reducing greenhouse gas emissions, will require massive change across the globe. He points to the mobile phone, email and the personal computer as models.

“These are radical social transformations,” said Khosla, 54, from his Sand Hill Road office. “In 2000, most people hadn’t heard the word Google. Massive change in fact happens all the time. It just feels improbable before it happens.”

Hatching technology eggs

Khosla has spent his career taking on entrenched giants, and thinking big.

Khosla drew up the business plan when he, former CEO Scott McNealy and Andy Bechtolsheim launched Sun Microsystems in 1982, a time when Khosla and McNealy shared an apartment. “We both looked at each other and said, ‘There aren’t going to be any small computer companies, so if we’re going to do this and do a belly flop, let’s empty out the pool,’” McNealy said.

By the early 1990s, he had moved on to venture capital titan Kleiner Perkins Caufield & Byers, where he made his first mark directing its investment in Nexgen, which was trying to compete with Intel in the microprocessing business.

“Most people said you can’t compete with Intel. But we built the chip and AMD bought the company and gave us a large percentage of the company — 27 or 28 percent,” Khosla said. “The greatest thing was we got involved when the company was in trouble and couldn’t get the financing done and there was all this risk. Fighting the odds was kind of fun.”

Juniper Networks, another company Kleiner Perkins incubated under Khosla’s direction, took on Cisco in the Internet router business. The company reportedly made Kleiner’s partners more than 1,000 times their money back. Juniper and two other networking companies he helped incubate and fund returned an estimated $4 billion to Kleiner Perkins partners.

Last year, Forbes estimated his net worth at $1.4 billion.

The learning curve

When he started Khosla Ventures, he chose to focus on cleantech because he liked to fund “science experiments” and because the markets — electricity production, transportation fuels, building materials, and more — are so incredibly big.

The ultimate experiment remains his ambition to get the world off oil.

He’s poured almost $140 million into no fewer than 10 alternative and renewable fuels companies. They include South San Francisco-based LS9 Inc., which engineers microbes to produce diesel fuel, and Amyris Biotechnologies Inc. in Emeryville. The latter started off developing vaccines and now uses its scientific platform to turn sugarcane stalks into ethanol in Brazil. Khosla’s portfolio also includes KiOR, a joint venture between Khosla’s venture capital firm and BIOeCON. That company is pursuing an easier and less expensive way to break down stuff like wood chips and switch grass to make biocrude oil.

Khosla said it will take many solutions to be able to compete with oil production and not all will succeed. He’s learning, too. He’s changed gears after promoting corn ethanol earlier this decade as a stepping stone to more advanced fuels.

“I think it’s time to move past food-based fuels partly because of politics, possibly because it won’t scale,” Khosla said.

But coal isn’t the solution either. To limit how much coal is being burned to produce electricity, Khosla invested in companies like Mountain View-based Ausra Inc., which has more than $31 million from his firm. Ausra develops solar thermal technology. The company recently dropped its aspirations to become a power plant developer long-term (it’s still trying to finance its initial plants in the Mojave Desert) but would sell its technology to others.

Khosla was on board quickly. Ausra CEO Bob Fishman said Khosla supported the change in strategy and that Khosla clearly wants to transform the energy marketplace, which includes installing Ausra technology wherever possible.

“What’s very clear to me is 10 Googles will be created in cleantech,” Khosla said. “Clearly many of the ones we’ve done have that potential. It’s really hard to say which ones. But when we (Kleiner Perkins partners) made the Google investment, it wasn’t clear it would be that big.”

Straight talker

Khosla is known for speaking his mind about well-meaning efforts that don’t quite make the grade.

At several events last year, he criticized San Francisco for paying hundreds of thousands of dollars to put solar panels on the Moscone Center — saying the city could achieve 40 percent more efficiency by renting the roof of the civic center in San Jose, which has 360 sunny days each year.

He’s dismissed clean technologies that he thinks won’t scale as “toys,” and openly criticized billionaire T. Boone Pickens’ plan to ramp up wind energy.

“He’s a very smart guy who has zero inhibitions around saying it like he thinks it is,” says former Sun colleague McNealy, who still lives next door — though they now inhabit neighboring expanses in Woodside.

CalPERS has committed $200 million of an estimated $1 billion fund Khosla is raising, the first for Khosla Ventures to accept third-party money. While he couldn’t comment on raising the new fund, Khosla said he’s confident that cleantech as a sector will generate the kind of returns for which Khosla is known.

“At this point I feel very comfortable that the probability of success is at least as high if not higher than if I was investing in IT or semiconductors or Internet startups,” Khosla said. “Four years ago I couldn’t have said that.”

lriddell@bizjournals.com / (415) 288-4968

article published at http://eastbay.bizjournals.com/sanfrancisco/stories/2009/03/09/focus1.html?b=1236571200^1789990&t=printable

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