VCs Warm Up to New IPO Craze

Greg Stanger knows how difficult it can be to take a company public, even in the best of times. A former Microsoft employee, Stanger became CFO of Expedia when the travel site was spun off and taken public in 1999.

Stanger also knows that even with the recent run-up in technology stocks and the prospect of at least one blockbuster IPO in the near future, these are not the best of times. Still, he is confident that smart venture capitalists can find good companies in strong and growing sectors — private companies that will be tomorrow’s impressive initial public offerings.

“We’ve gotten well beyond the point where people are allergic to investing in Internet companies,” said Stanger, who recently signed on as executive in residence at Palo Alto, California-based Technology Crossover Ventures (TCV).

Warning: Boom Ahead?

However, whether a lessening of fear portends another boom time for venture investing in tech firms is still up for debate, with many observers on the fence about the prospects.

Some industry watchers are awaiting the long-anticipated and much ballyhooed Google IPO, saying that, while unique, it still could serve as a barometer of how hungry the investing public is for new-issue technology stocks. Google has not set a date for its offering but has begun preliminary steps, including hiring underwriters.

Software firm Salesforce.com also has filed to go public, and industry observers say a few big offerings could clear the way for a rash of smaller niche firms that have been operating profitably for some time to make their Wall Street debuts.

Baby Steps

Even without a Google-size IPO, the economic climate is markedly better for venture capitalists seeking exit strategies. There have been scores of mergers and acquisitions in the past year, many involving small, privately held and venture-backed firms.

“We’re beginning to see the IPO and acquisition markets improve, but it’s going to take time before that starts to feed back into better performance for venture funds,” National Venture Capital Association president Mark Heesen told the E-Commerce Times.

Heesen said that although a good run of IPOs could help win over any remaining high-tech skeptics, most companies have kept their funding levels steady through the downturn anyway. “You would see additional liquidity, but no one is predicting a return to the late 1990s,” he noted.

Even without another boom, venture capital remains a good way for investors who are comfortable with risk to put their money to work. According to the NVCA, the average return for venture funds for the five years between 1998 and 2003 was more than 25 percent. By comparison, the Nasdaq had gains of just over 1 percent during the same stretch.

Moreover, VC valuations made their biggest gain in the past few years during the fourth quarter, driven mainly by acquisition activity. “The liquidity those higher valuations represent will mean more money to go around for firms looking to be funded,” Heesen added.

Exit, Stage Late

The impact of more IPOs and buyouts may be felt most by firms like TCV. Stanger noted that the firm generally invests in late-stage companies — ones that may need a final round of private capital before being launched into the public markets. TCV also typically holds on to its interest well after the offering takes place. For instance, the firm only sold its remaining Expedia shares when USA Interactive bought the company last March.

“It’s a longer investment horizon, which is healthy in a time when there [are] no quick fixes,” Stanger said.

Other venture firms are not expecting returns to come easily again, and industry watchers say investors will not change their strategies much to match the mood of Wall Street.

“Most venture investors have seen their share of bubbles come and go and understand that the basics — the fundamentals — are what are going to matter in the end,” John Balen, a partner at Menlo Park, California-based VC firm Canaan Partners, told the E-Commerce Times. “If you continually invest in solid companies in growing markets where profitability can be achieved consistently, one way or another you’ll come out ahead.

“Our M.O. has always been that this is a long-term business and you’ve got to avoid short-term sensitivities,” Balen added. “We don’t want to go back to where companies were being taken out too early and burning too hot too fast. Our job is to identify the startups that can be strong companies and then help them get there.”

Happy Days

Stanger and TCV are equally optimistic that there are still plenty of good startups out there. In February, the firm announced it had raised $900 million to invest in technology firms. That money reflects a wider belief that the technology and e-commerce sectors may be poised for a second wave of successful IPOs.

This time, however, the companies will have track records of profitability as well as eye-dazzling growth. TCV has been one of the e-commerce sector’s best friends in the downturn, helping to take firms like Netflix public when the IPO window otherwise remained shut tight.

“The sector had its initial day in the sun,” Stanger said of the Internet. “A lot of companies got washed out. Now it’s not just showing signs of life, it’s showing real traction. Some of the companies have been able to survive, to rearchitect themselves and develop businesses that make a lot of sense.”

Specifically, he said TCV sees opportunities in several fields in the Internet space, including Web analytics and search. Also on the firm’s radar screen are startups that can aid online comparison shopping and even traditional e-commerce-style companies that are finding new ways to sell what have to date been considered offline items.

“We’re not the only ones to recognize that there’s new opportunities in the same space,” he added. “In fact, deals are becoming a lot more competitive.”

Wait and See

Still, others will want solid proof that the rebound consists of more than just Google and a few other companies, according to attorney David Millard of Indianapolis-based Barnes & Thornburg.

“What we see Google do is not indicative of the rest of the market, in my judgment,” Millard told the E-Commerce Times. “I don’t think the VCs are warming up yet. I think they are going to want to see more sustained evidence of the IPO market catching fire and M&A multiples returning. The trend line is heading the right direction for a change, but it’s too early to trumpet the return of the VCs.”