The IPO Head Fake
Posted on | September 14, 2009 | 1 Comment
The resurgence of NASDAQ this year, the successful IPOs this year of Open Table and a few others, the recent S-1 filing of Fortinet, Inc., and the anticipated filings of other notable private Silicon Valley companies have sparked hope that the IPO market is coming back. Of course, this is of enormous significance to the VC and Silicon Valley community. Perhaps (and hopefully) it will, but I don’t think so.
Much blame has been heaped upon the burden Sarbanes-Oxley places on public companies which, of course, is hugely onerous for small companies. Yet I think there are other villains also responsible for the collapse of the IPO market, and which may prove more intractable and difficult to solve:
- The decimalization of the stock market and crushed commissions. Stocks used to trade in increments of eighths (12.5 cents) or, occasionally, sixteenths of a dollar. They now trade in 1 or 2 cent increments, and with that comes much-diminished market-making profits.
- Lack of small company analyst coverage. The principal villain here is Client #9, aka Eliot Spitzer, who went after Wall Street with a vengeance in the aftermath of the DotCom meltdown and their ridiculous research reports and market hype of the day (see Blodget, Henry, for example). The result was a cleaving of equity research operations from investment banking and the virtual extinction of small company coverage. I started my career as a stockbroker, and I can tell you that an old Wall Street adage is true: stocks are sold, not bought, no differently than toothpaste or beer. It takes an enthusiastic and credible research analyst to motivate a sales force to sell IPOs, and to provide coverage of that company to the investors after the IPO. No coverage, no interest, no investment.
- The consolidation of Wall Street. Today the hegemony of the big investment banks like Goldman Sachs, Morgan Stanley & Credit Suise (Robbie, Montgomery & H&Q, R.I.P.) dominate underwritings. Can these big firms afford to court and service small tech companies?
The sub-$50 million IPO is nearly extinct. Pascal Levensohn has a great blog post on this subject, which I highly recommend. Of the 39 S-1 filed during Q2-Q3 listed on Hoover’s IPO Central, only 2 are under $50 million. During the decade of the ‘90s roughly 80% of IPOs were under $50 million; since, roughly the inverse is true.
The average time from initial investment to liquidity in VC portfolios used to average about 4½ years; now it’s more than doubled. For the average VC fund with a 10-year horizon, that’s a Big Problem. The National Venture Capital Association, under the leadership of its former chairman, Dixon Doll of DCM, has devoted a lot of time and thought to the problem of illiquidity in VC portfolios, and has developed a 4-pillar plan to restore it.
But don’t assume some IPOs this year mean the problem is solving itself; it isn’t. It isn’t just VC portfolios at stake; it’s about U.S. technology competitiveness and innovation in Silicon Valley. Write your Congressperson.
- Jeff Kuhn, Managing Partner
The Lonely CFO
Posted on | September 1, 2009 | No Comments
The profession of being a CFO has changed a lot since Sarbanes-Oxley in 2002. The pre-Sarbanes era seems like a distant memory; pre-SOX, a CFO was able to draw upon the technical expertise, resources and counsel of his or her auditor, audit chair and outside counsel. I used to run ideas, concerns and questions by my audit partners all the time, in a friendly and collaborative way. Sure, good execution was always expected, and when it came time to for the annual Management Letter review with the audit committee you knew that was a big deal. But if you needed help, you could get it, often in a non-judgmental way. The CFO role was more circumscribed, and corporate governance was, shall we say, more casual.
No more. Since Sarbanes the roles have shifted dramatically. Auditors cannot be so collaborative and there’s much more independence and self-sufficiency expected and required. Those collaborative conversations don’t happen any more (I’ve had auditors tell me “we know what the answer is, but we can’t tell the client; they’ve got to figure it out for themselves, and we’ll tell them if they got it right.”). Audit partners are forced to rotate off of clients after a few years, boards are demanding precision and leadership from their CFOs, and lackadaisical execution is simply not excused. Can you spell Material Weakness?
On top of that, the regulators are very active. The High Priests of FASB and their brethren in the other alphabet soup regulating authorities publish pronouncement after exposure draft after bulletin after regulation, in an almost publish-or-perish frenzy. If you think the Internal Revenue Code is big, check out GAAP and the related guidance. I recall an accounting professor telling me that the only number on a balance sheet that was a fact was cash; everything else was an opinion. While maybe not strictly true, it makes a good point.
In the last several years we’ve seen much angst about the expensing of stock options and the options backdating fiasco. Compliance costs for all matter of issues have zoomed, independent of SOX. Accounting matters have become politicized: after the fall of Lehman and Bear Sterns a year ago, and the near-death of AIG, Merrill, BofA and the rest, FAS 157 made front page news. Mark-to-market rules came under intense scrutiny; in what other times do accounting principles make the op-ed pages and the national news?
Boards and CEOs have expanded the role of the CFO; he or she is no longer thought of as just the keeper of the books. Strategist, fundraiser, business partner, corporate consigliere, compliance officer all apply. Recently business school professors Tulimieri and Banai argued in an article in the Wall St. Journal for the elevation of the CFO office to co-CEO (Move Over, CEO, August 17, 2009).
And lastly, here in Silicon Valley the normal routes to liquidity shifted from 90/10 IPO/M&A to the reverse, and for the last couple of years there has been no IPO market at all, period; just M&A. Merge two companies and you have a surplus CFO.
So what, you say. Well, all of this has ratcheted up the scrutiny on and expectations from the CFO. This profession is now a high-wire act with no net, and volatility in the CFO office has increased dramatically. I’ve heard respected executive recruiters tell me that they think the average tenure of a CFO in the Valley is something under 30 months, maybe much less. Make no mistake: the wheat, as it were, is being separated from the chaff.
The six of us who founded FLG nearly 6 years ago did so on the premise that these large trends meant that there was an opportunity to create a unique firm to deliver on-demand CFO excellence to companies large and small, and to replicate the collaborative, expertise-sharing culture and client service delivery that typifies the best accounting and law firms in the Valley, but in the CFO arena. Just as one can be a great solo accountant or lawyer, one can be a great solo CFO; but combining the expertise and resources of your peers into a firm has clear and significant benefits to both the individual and the client.
As David Hornick of August Capital has observed in his blog (“Welcoming Howard Hartenbaum to August Capital”), building and running a successful collegial partnership is very hard, and that’s why they’re rare. They’re also fragile, but we’ve found that can be overcome by being very discriminating about who are admitted as partners, sharing a clear common vision, and nurturing and jealously protecting our culture. FLG now has 20 partners, each of whom are smart, accomplished veterans of the CFO wars in their respective rights. We don’t aspire to be the biggest firm in our space; in fact, I doubt we’ll get much larger. But we are unique, and we do aspire to be the best at what we do.
- Jeff Kuhn, Managing Partner
