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Where did they go?

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Monday, December 01, 2008
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WHAT DOES IT MATTER THAT OREGON HASN'T SEEN AN IPO FOR YEARS?

BY ABRAHAM HYATT

As 2008 slowly unfurled, the United States found itself in the biggest IPO drought since the late 1970s — a historical milestone that’s been overshadowed by this year’s other earth-shattering economic headlines.


In the first three quarters of the year, only six venture-backed startups went public in the U.S. Compare that with 55 IPOs in the first three quarters of 2007, or 233 companies over the course of 1999. Or compare it to the number of years since Oregon’s last IPO: four.

Part of the blame for the lack of IPOs can be laid at the feet of a familiar bugbear: Sarbanes-Oxley. But declining numbers are to be expected. The IPO heydays of the 1990s were a singular moment. The tech markets have matured, says Bill Campbell, a partner at Portland law firm Ater Wynne, and their stocks aren’t getting the kind of growth that drives investors to put huge amounts of money back into the industry.

Expected or not, the decrease in IPOs has put funding for Oregon’s startups and venture investors at risk — keeping investors’ money tied up in companies that can’t go public has far-reaching repercussions. There are also impacts to the state that come from a lack of growth in its largest companies.

Oregon companies that have put off going public because of the bad IPO market don’t seem to be worried about the future. Earlier this year, Portland’s Tripwire, which develops software for IT systems, pulled back from its plans to go public. The company has been reporting record growth this year and has, according to company spokeswoman Kim Blomgren, no problem waiting. “There are a lot of doors open for us, whether it’s someone large coming along who’s interested in us or whether we take advantage of an IPO.”

Another Portland company that had been considering an IPO, Integra Telcom, a fiber optics communications company, is happily sitting on its heels as well. According to spokesperson John Nee, the company, which has grown explosively in recent years due to acquisitions, will focus on internal integration projects and its core markets until the IPO market improves.

Because of the concurrent drop in the economy, it’s difficult to quantify what the exact impact of the loss of IPOs has meant to Oregon. It’s possibly changing the funding atmosphere, but there are not any hard numbers. VC spending in the state has dropped this year, but the reasons are multifaceted. It would be impossible to calculate which percentage was caused by the state and national IPO numbers.

Which means that so far, the historic drop in IPOs isn’t changing how Oregon startups and venture investors are doing business. But there are enough risks that things could change, even for the faction of the tech industry that say they don’t plan on ever going public.


One IPO in four years sounds like a tiny number. But put it in perspective, says Gerry Langeler, managing director of OVP Venture Partners in Portland and Seattle. “This is a really important point: People think 1999 was normal. It was completely abnormal,” he says.

Which means that for Oregon, “normal” means “not that far from zero.” According to IPOhome.com, the research division of Connecticut-based Renaissance Capital, Oregon had four IPOs in 1999, three in 2000, one in 2001 and two in 2005, Beaverton’s Cascade Microtech and Portland’s McCormick & Schmick’s. Portland General Electric, often cited as the state’s most recent IPO, was not technically a public offering of stock but a distribution of stock to creditors that occurred as part of former-parent-company Enron’s bankruptcy proceedings.

Small numbers may be normal, but having none at all may have a negative impact on the state. Prem Mathew, an assistant professor at Oregon State University’s College of Business, points to the psychological effect the lack of Oregon IPOs has on investors. Attracting new venture money to an area is difficult without previous success stories. It’s similar to the anecdotal boosterism impact of IPOs — the punch in the arm the state and its business community gets when a high-profile company goes public and (presumably) grows.

There are also potential downsides from the national no-IPO trend. Oregon is connected to the larger VC funding universe. If investors can’t take their companies public, then the investors can’t reinvest their money in new, smaller startups. Companies waiting to go public need money to stay afloat but can’t afford to take on debt in the current credit cycle, which leaves investors spending more on them and again, not on smaller startups.

“Good exits are really important, because a steady stream of good exits replenishes the early-stage money supply on which the innovation economy depends,” says Ater Wynne’s Campbell. “If that money stays tied up in illiquid companies, it can’t be put back to work in the next deal, and the whole cycle gets jammed up.”

It’s difficult, however, to quantify the impact of all of those risks; there are multiple economic variables in any change, up or down, in VC activity. For instance, according to data attributed to Dow Jones VentureSource, venture funding is down in Oregon in the third quarter of this year but has been strong the last two years. Will a recovering economy push the level of VC spending to a higher level than before, or will it take a new IPO? Currently there are no IPOs in the pipeline. In 2008, Tripwire and Integra pulled back from plans to go public. That follows a national trend: 71 IPOs were withheld or postponed in the first three quarters of this year (compared to 16 in 2007), according to IPOhome.com.

It may take a while for those companies that are waiting to go public. Brian Adams, an assistant professor at the Pamplin School of Business at the University of Portland, says multiple elements of the economy, like credit, will need to improve before the IPO environment improves.

How long could that be? Analysts say it may take until 2010 for a rebound to occur.

IPOchart

DON’T BLAME SOX FOR THE FALLOFF OF IPOS



One commonly cited reason for the drop in IPOs is Sarbanes-Oxley — also known as Sarbox, or SOX, or any number of expletives typically not found in boardrooms. Since the passage of the regulatory- and ethics-reform act in 2002, companies have been required to follow a complex and costly set of regulations before going public. Because of the legal risk associated with not meeting the standards set by Sarbox, the law is regularly cited as a reason for the decrease in public offerings.  As Gerry Langeler, managing director of OVP Venture Partners, puts it, “It’s been a damper.”

But it’s not just Sarbox that’s to blame for the decrease. For instance, competition from China and other Asian companies has pulled IPOs to other capital markets. Research by the London firm Oxera Consulting found that even small details like the comparatively high fees charged by U.S. investment banking firms could influence IPO decisions.

“Personally, I think there’s a great deal of blustering about Sarbanes-Oxley and IPOs that doesn’t have a great deal of merit. It’s an excuse, not a cause,” says Rick Turoczy, owner of Return, a startup-focused consultancy firm in Portland. “For companies considering an IPO, SOX is just another cost of going public.”


The year 2010 only matters to startups dreaming of going public. Others are taking a different route.

“That big-company mentality is of little interest to many of the entrepreneurs to whom I speak on a regular basis. The people building the new Web-based services around here aren’t interesting in becoming publicly held corporations,” says Rick Turoczy, owner of Return, a startup-focused consultancy firm in Portland. “It’s based on personal satisfaction rather than world domination. And that mentality doesn’t play in the IPO market at all.”

The dot-com crash of the late 1990s taught many subsequent startups the perils of an IPO. Since then, the merger and acquisition route for tech companies has looked pretty attractive, especially when it’s a company like Google that’s doing the buying. Turoczy argues that MAs may be more viable than IPOs for the state’s web-tech startups. He tracks the potential path: Small company develops its own technology. Big company buys small company, essentially purchasing its own research and development. Small company owners get to start again on a new company. He lists  three examples of Portland entrepreneurs who’ve followed that cycle: Pete Grillo of Iterasi, Ray King at AboutUs and Craig Barnes, whose latest company is called Panels.

“For Oregon’s culture, it’s really a much more viable model than the IPO route,” says Turoczy. “We get to leverage our creativity to create a solution and we still garner a payout similar to IPO payouts. On the upside, that payout comes without all of the corporate baggage.”

Turoczy is referring to a specific subset of the tech industry. Whether that turns into a long-term trend, or spreads to other sectors, is debatable. Some industry analysts such as OSU’s Mathew thinks a trend is possible. Scott Darling, a general partner at Seattle’s Frazier Ventures, doesn’t.

“No, I don’t believe that. At the end of the day [investors] are measured on how their investments perform. If you look at the data there’s no question that IPOs have substantially better returns than an MA exit,” he says.

Better returns are why investors put so much high-risk money into companies in the first place. The only way to get liquidity is through an IPO or an MA, says Campbell.

“It’s a rare merger or acquisition that produces truly upside values. The most lucrative exit is usually an IPO, if it’s available,” he says. “Lucrative exits are important because this is very high-risk money. Getting the occasional 10 times or 30 times return is awfully important to encourage investors to keep playing.”

The true cost of going public is borne by investors. And Darling says he’s “mildly optimistic” about what the current IPO market means for investors. First, the region isn’t overly reliant on the kinds of startups that investors have found to be struggling long-term, such as the capital-intensive semiconductor industry that in Silicon Forest already has gone through its initial growth stage. “I don’t want to overemphasize it, but the Northwest tends to [have investments focused] in healthier areas,” he says, citing the open source and “software as a service” industries as examples.  

Darling’s second reason is that the valuation of startup companies has dropped, which is good news for investors. Lastly, “all the repetitive, imitative startups get boiled out in tough economic times. The people who are innovating are really innovating,” he says. “That’s what is important for [a startup’s] long-term health.”

While there are exceptions, there will always be Oregon companies that want to take that long-term health to Wall Street. The only question is, how long it will take for that to happen again?


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