Even during the worst of times when the dot-com bubble burst and tumbleweeds rolled in, we never saw less than 10 venture-backed IPOs in any 12-month period. This underscores the desperate times for liquidity-starved venture capitalists, who have always depended on IPOs as the best way to pull in a giant internal rate of return.
After no VC-backed company went public in the second quarter - the first such quarter since 1978, according to the National Venture Capital Association - the trade group went so far as to declare the situation "a capital markets crisis for the start-up community."
Some in the industry snickered at the NVCA's use of "crisis" at the time, but it's become abundantly clear since then that the IPO process for small companies is indeed flawed - from how institutional investors get introduced to young companies to the process involving analyst coverage of these companies.
The situation sure has the industry in a tizzy. The NVCA late last year established task forces made up of securities experts to try to find ways the private sector, and possibly Congress, can fix the IPO process. Those recommendations haven't yet been released.
Some venture capital firms have taken matters into their own hands, forming a new venture, called InsideVenture Inc., that affords institutional investors opportunities to meet with executives of venture-backed companies along with giving them online access to confidential information about the companies. The idea is to get the qualified institutional buyers to buy in before the IPO, thereby giving them more access to shares, and to give companies more access to long-term investors to mitigate a slide in stock price. InsideVenture is holding its first conference next week in Santa Barbara, Calif.
What also might help investors and entrepreneurs is a private stock market for exchanging shares of venture-backed companies, where entrepreneurs and VCs could list their stock for sale to potential investors.
That market might be around the corner. Nasdaq has been looking to launch an unregistered venture capital market so institutional and accredited investors can trade stakes in early-stage companies. Dow Jones Newswires, citing a presentation given by Nasdaq to the Securities and Exchange Commission, reported today that Nasdaq wants the SEC to change a rule that allows only qualified institutional investors, or QIBs, to trade positions in the unregistered securities market, and to extend a safe-harbor rule to accredited investors. Currently, Nasdaq's Portal market, which launched two years ago, only allows these QIBs to trade shares. (Read the Newswires story here via VentureWire.)
These drastic measures should help, but it's also clear that VCs need to build more financially healthy companies. Of the 14 non-health-care venture-backed companies that were left in IPO registration at the end of the year, six produced a profit in 2007, while only three generated revenue above $100 million, the oft-mentioned threshold underwriters use to gauge whether a company is ready for an IPO.
This brings us back to Rackspace. How did it manage to go public at a time when the stock markets were badly bruised? The answer is simple: Rackspace makes money. It posted 2007 revenue of $362 million, up 62% from the year before and better than nearly all companies in registration for IPOs. It has also been profitable for at least five years, a rarity among start-ups.
A month after Rackspace's IPO, the collapse of Lehman Brothers Holdings Inc. sent the stock market into a tailspin, making it nearly impossible for any company to go public. But once the Dow Jones Industrial Average trudges back upwards and loses the volatility that characterized most of 2008, venture capitalists may have their time in the sun again. Hopefully by then, they will have ironed out some of the kinks in the IPO process - and revenue-producers like Rackspace won't be a rarity among venture-backed companies.
