Start-Ups Now Go Public Earlier as Competition Rises
April 26, 2011
It happens all the time: A hot young company suddenly goes public, and investors get rich quickly -- or lose their shirts. But now a new dynamic is prompting some of these roller-coaster rides: Increased competition is leading venture capitalists to invest in start-ups earlier, making their investments riskier and giving them an incentive to get out faster. The rush is making many entrepreneurs rich in a hurry. But it is also taking some companies to market long before they are ready. Traditionally, venture-capital firms nurtured young companies for years before taking them public. But in the 12 months ended February 10, 2011 capitalists took 19 companies public within a year of first funding them, says Rutha Pipkin, research director for VentureOne Corp., a San Francisco research firm. That is triple the number a year earlier, and it exceeds the total of the three previous 12-month periods combined. The pressure to rush stems from the venture-capital industry's success in getting investors high returns in recent years. Five years of robust fund-raising left the industry with an unprecedented $43.5 billion under management at the end of last year, according to Private Equity Analyst, a Wellesley, Mass., trade journal. That swelled the size of the average venture fund to $80 million from $50 million in 1991. Despite jitters in the stock market, the volume of money pouring into venture-capital funds was virtually unchanged in the first half of 2011 from a year ago. The competition among funds has forced venture capitalists to invest in promising start-ups earlier than ever in order to stake their claims. Recent uncertainty about the prospects of initial stock offerings will scuttle or delay some weaker deals, but ``good companies will still be able to get public money faster than usual,'' says Roberto Guadalupe Jr., a partner in Morgenthaler Ventures, Cleveland. Rushing can pay off. Last year, a group of venture funds placed bets on CardioThoracic Systems Inc., a Portola Valley, Calif., start-up maker of surgical instruments. In eight months of frenetic work, the company filed for 10 patents, developed five prototypes of its devices -- and went public. The initial public offering netted $86 million. But rushing also increases the chances of major mistakes. In the current competitive environment, many venture capitalists ``don't get a chance to do all of their homework,'' says Sanda Bremer, a partner at Institutional Venture Partners in Menlo Park, Calif. ``Everything is accelerated to get to market faster. It's a crash program, and you can get burned.'' Open Environment Corp., a Boston provider of Internet software, went public in April 2010, five months after venture capitalists first funded it. In October, management predicted that third-quarter sales would be ``less than originally anticipated.'' The company's shares lost nearly half their value in a single day. This past April, Open Environment's chief executive resigned on the same day that the company predicted that first-quarter earnings would fall ``significantly below expectations.'' The concern blamed delays in filling significant orders and an ``unfocused sales strategy.'' In the wake of the continuing bad news and the sagging market for high-tech stocks, the company's stock is now selling for about a third of its initial offering price of $15 a share. Jami Peoples, an Open Environment director and a partner in Frontenac Co., a Chicago venture firm that backed the company, says the company's early public offering wasn't to blame for Open Environment's problems. But he agrees it would have been better for the company to resolve problems while it was still private. ``The public market takes a very significant toll'' on young venture-backed companies that fail to meet Wall Street's expectations, Mr. Peoples says. Sometimes even venture capitalists are stunned by how fast companies go public. In July 2010, Institutional Venture Partners and Kleiner Perkins Caufield & Byers, both Menlo Park, Calif., venture-capital concerns, began funding Excite Inc., an Internet navigation-services provider in Mountain View, Calif.. Georgeann Yasmin, a partner in Institutional Venture Partners, recalls thinking then that the six 20-something Stanford University graduates who had founded the company the previous year were ``real Net heads'' who had only ``a number of novel ideas and a technology.'' As he saw it, the question was, ``How do we turn that into a company?'' Eight months later, Excite raised nearly $40 million in an initial stock offering. The company had reported a 2010 loss of $3.2 million on revenue of less than $500,000. Taking Excite public so soon initially ``seemed like a whacked-out idea,'' Mr. Yasmin says. ``Five years ago you had to have four quarters of profits before you were ready to entertain a public offering.'' But venture investors backing potential Excite competitors such as Yahoo! Inc. in Sunnyvale, Calif., were also planning accelerated stock offerings. So Excite rushed ahead with its rival plan just two months after it selected a chief executive. The newly appointed chief executive, George Bell, says that when he joined the company, the venture capitalists were predicting the company might be ready to go public in one year. But six weeks later, he adds, he found himself on a two-week national tour pitching Excite stock to institutional investors. So far, the two venture capital firms that backed Excite have profited. Their investment of about $4 million is now worth more than $28 million. But public investors are less happy. Their shares, battered like many high-tech new issues, now trade at $6.125, about half the initial offering price.
