Silicon Valley Frontlines

The Ten Hottest Private Companies in Tech - Good News for the Valley in 2011?

The good folks at Mashable just published a list of the Ten Hottest Private Companies in Tech, based on a survey by SecondMarket. SecondMarket is a rapidly growing exchange offering (among other things) the opportunity for sellers and buyers to trade private company stock prior to an IPO or other typical public liquidity event. (We can discuss another time how these exchanges operate but they are indeed offering a valuable service to liquidity seekers and prospective buyers). SecondMarket surveyed their buyers and potential buyers about these companies and, In order of most- to least-interest, they are:

1. Facebook
2. LinkedIn
3. Twitter
4. Zynga
5. Craigslist
6. Groupon
7. Yelp
8. SecondMarket(!)
9. Pandora
10. Bloom Energy

As an avid Silicon Valley fan, I love the fact that all except Groupon and SecondMarket itself are Valley companies. And all, except possibly the wacky guys at Craigslist, represent possible IPO opportunities in 2011. And this doesn't even include Skype (new headquarters in Palo Alto; IPO about to spring loose), Art.com, MedeAnalytics (both East Bay) and others in the wings.

Five great outcomes of some or all of these IPO'ing in 2011:

1. Liquidity events are a key driver of VC investment sentiment. While much of that liquidity happens through M&A activity, the big splashes and payoffs from IPO's will enable portfolios to show substantial returns, raise new funds and have the confidence to invest in new startups or growing existing ones.
2. More cash into the Valley economy from employees selling stock, hopefully stabilizing and improving the housing market and the general ecosystem.
3. Greater momentum on the job front as newly public companies scale up with the proceeds (at this stage they are not cash hoarders like the Apples of the world!).
4. A boost to the California economy and budget. Not only does the ripple effect of spending spread across the state but the taxes paid by employees and others in exercising and selling stock would be substantial. In 2006 California personal income tax receipts grew by $4.3 billion from the prior year due in no small measure to employees and others selling their Google stock. During that time Google's market cap grew from $70 billion to $100 billion - and as it happens many people believe Facebook is already approaching the lower number in that range.
5. Talking of which, one benefit is that it would not be all about Google any more ....!

Agreed, all this takes time to ripple through the system. For example, shareholders in an IPO usually have to wait 6 months in a lock-up period before they can actually sell. But sustained benefit over a long period is better anyway ...

Related articles

• The 10 Hottest Private Companies in Tech [REPORT] (mashable.com)
• SecondMarket Releases Q3 Private Company Stock Trading Report (eon.businesswire.com)

IPO's and M&A Exits Continued to Improve in Q3 ... Good News for the Trickle-Down Effect

As noted many times before, the availability of funding for startups is heavily influenced by the state of the market for exits - IPO's or acquisitions. If investors don't think they will be able to exit an investment down the road then they won't tend to make it in the first place (duh!). Somewhat illogically, this has very immediate impact on new investments even though the exit will be years down the road and subject to whatever market conditions then exist, going to show that emotion and sentiment is still a significant factor in current decisions.

They good news in Q3 2010 is that while IPO's continued to improve from last year, the sales of venture-backed companies in M&A activities (including two of my prior startups or clients, yea!) increased substantially. This has the effect of (eventually) encouraging more money to go into startups as individuals cashing out then start new companies or become angel investors, and from traditional VC's seeing positive outcomes. In addition more money comes into the local economy from employees and individuals cashing out and buying houses and cars and the usual trappings of success/hard work. (Of course, IPO's aren't strictly exit events but for most earlier-stage VC's they are the start of that process).

According to Thomson Reuters and NVCA there were 14 venture-backed IPO's in Q3, for a total of 40 for this year-to-date, compared to just 18 in 2008 and 2009 combined. The average IPO took 6.7 years and $51m in funding to get there. An additional 49 venture-backed companies are on file with plans to IPO in the near future, representing a healthy pipeline for the rest of the year and into 2011. And of course not including - yet - Facebook, Zynga, LinkedIn or some other hot Valley companies!

Total M&A deals involving venture-backed companies in Q3 were 104, and 322 year-to-date compared to 173 in all of 2009. Two-thirds of the 104 were for computer software or internet companies. The average time it took a venture-backed company to achieve an M&A exit in Q3 was 4.8 years (20% less time than last year's exits) and an average of $23m in venture capital to get there (versus an average $27m in exit proceeds). The latter suggests that on average VC's don't make much money on their investments so it's interesting to look at an analysis of the values of the transactions versus the amounts invested in these companies (so much for averages!):

Analysis of Transaction Values versus Amount Invested
Relationship between transaction  value and investment		Q1 10 M&A **		Q2 10 M&A **		Q310 M&A **
Deals where transaction value is less than total venture investment		9		3		7
Deals where transaction value is 1-4x total venture investment		7		4		11
Deals where transaction value is 4x-10x total venture investment		9		9		4
Deals where transaction value is greater than 10x venture investment		4		4		5
Total Disclosed Deals		29		20		27
Source: Thomson Reuters & National Venture Capital Association

I'd expect the overall M&A trend to continue and even accelerate as large tech firms, flush with cash, put some of that money to work (as they should do in the interests of improving stockholder returns over time rather than just punting with stock buybacks or starting to pay dividends). 

The reality is that, despite the improvement, an IPO continues to be a hard way to find an exit with more and more companies tending to sell themselves (as we see above) or delaying or avoiding such events until they literally have to. You may remember Google's IPO timing was heavily affected by the company getting to the point of having more than 500 individual stockolders, a key statutory threshold for being considered "publicly held" and almost by default. Facebook has avoided this by allowing big investors to come in and provide liquidity in the near-term to certain employees and others in private transactions and I'll discuss more of this in a future post.

Sources: Thomson Reuters, National Venture Capital Association and Dow Jones VentureWire

Rugs to Riches - Saeed Amidi and the Plug and Play Silicon Valley Story!

If you want to get a first-hand, very intimate view of growing a successful business in Silicon Valley in the age of the internet then listen to this 30-minute segment from BBC Radio 4's In Business programme (listen online or download as a podcast). 

Actually it's the story of Saeed Amidi and his family's transition from leaving Iran prior to the revolution and, because they could not then go back, how they made their way in Silicon Valley. Saeed is now a good friend of mine as we've worked together for a couple of years at his Plug an Play incubator in Sunnyvale and the story is a great example of why Silicon Valley is the one and only Silicon Valley!

It starts with storing their family rugs in a building on University Avenue in Palo Alto - behind papered up windows - and then accidentally getting into selling the rugs after they tear down the paper. This leads to meeting successful VC's and executives of recent IPOs who want ... rugs for their mansions. Saeed buys the building (listen to how he deals with being told by Mr. Pappan, his landlord, that the building is for sale for $1 million but Pappan tells him he'll have to pay $1.2 million because he's always late with his rent) and then starts renting space to startups. Not just any startups but in part through his rug connections its to the fledgling Google, Paypal, Danger and Logitech. A few times it's mentioned that this is a "lucky building". I should think so. Foursquare is in there now! Here's a photo of the first group of Google employees in front of that building, 165 University Avenue.

Of course Saeed was not just a landlord. He was smart enough to ask for equity in each company as part of the deal to rent the space. When you look at the list you know just how smart this was!

Then the story broadens out into the bigger Plug and Play operation that Saeed has built since then, including the 160,000 square foot incubator in Sunnyvale, a former Phillips Semiconductor plant that was empty for 6 years before Saeed bought it in 2006. Plug and Play is now a vast ecosystem of startups (over 200), events, venture capital meetings, cloud computing services, Executives-in-Residence (I'm one, part time) and so on. Now Saeed is looking to broaden further, bringing startups here from all over the world - Canada, Asia, Italy, Spain, you name it - and starting to brand the Plug and Play operation into places like Singapore.

It's an American-immigrant-makes-good story. And its a Silicon Valley as the center-of-the-tech-startup-universe story. And its a we-can-help-the-world story. I love it!

Solyndra's IPO - Not a "Going Concern", But Hoping It's a Big Success!

As I've noted before, there are many companies now in the backlog of IPO's filed but not yet completed. One of them, the cleantech company Solyndra, is worth taking a closer look at because of its rather unique characteristics. This high-profile solar panel business has raised a whopping $961 million in venture financing since it began and has been in registration since mid-December last year. It's looking to raise about $300 million from the public offering. Sound like a lot? Well, yes, but they need a lot!

Since introducing it's unique cylindrical components and related panels Solyndra has grown revenues from zero in 2007 to $6 million in 2008 and to $100 million in 2009 - astonishing growth but for the unfortunate fact that it still costs the company a lot more to make the panels than they can sell them for. For that $100m in 2009 revenues it cost them $162m to manufacture the product - and then another $115m to develop, market, sell and cover overheads. So for those at home keeping score they spent $277m to produce that $100m in revenues. It's still better - relatively speaking - than the $228m they spent in 2008 to produce just that $6m in revenues ....

This is not a typical business, even for the sometimes-extreme Valley! Here's a company whose products are clearly state-of-the-art but where, after raising and spending almost a billion dollars, the true economics of producing and selling them are yet to materialize. In fact their auditors PriceWaterhouse Coopers, have just issued what's known as a "going concern" opinion about the company. To backtrack for a second, all companies looking to go public via an IPO have to file an S-1 registration statement with the SEC which has to include three years worth of detailed, audited financial statements along with an additional two years of summary financial information, assuming the company has been around that long. As part of those statements the auditors issue an opinion, basically saying that those statements fairly represent the historical financial position and results of the business.

While this opinion is largely a rear-view mirror look the auditors are required to do some procedures to determine whether it is able to operate as a "going concern" in the future as a viable stand-alone business. The typical approach - and rule of thumb - is that it is is a going concern if it has enough cash on hand to run the business for twelve months from the date of the audit opinion (in essence, the date the auditors sign off on the period they just audited). The auditors won't be able to assume future additional financing (including the IPO) because that may not happen. Nor can they assume some rapid growth or improvement in the business that suddenly makes it cash-flow positive. The most likely thing is that it continues as it just left off in the most recent year. So lets look at some of those numbers. 

In the year ended January 2, 2010 it spent $170m in cash just running its daily operating activities (basically the loss it incurred in selling the $100m of product plus its operating expenses and various other adjustments). It also had to build it's production facilities and make other capital investments - which totaled another $175m. So there's almost $350m - millon! - of cash consumed in one year.

How did they finance that, because the money came from somewhere? Well, they raised $336m in venture financing (part of the $961m I mentioned above) which included converting some existing loans into equity (an ownership stake), and took on an additional $140m in debt. That debt is worth looking at - its money they have borrowed against a $535m loan facility guaranteed by the Department of Energy and is money coming from the Federal government's economic stimulus and recovery commitments. It has to be used for the building of Solyndra's second production plant in the Valley (those of you who regularly travel on Highway 880 in Fremont will see the first plant right by the Eastern side of the road) and which Solyndra itself must finance at least 27% on its own in addition to the DOE guaranteed loans.

At the end of 2009 where did all this leave the company? Well, it had $50m cash in the bank (it also had $151m of further cash on the balance sheet, but that cash is restricted and can't be used for regular operations). And the customers who bought the $100m in products still owed it $34m in remaining payments for them. Against that it owed $105m in current liabilities (payments for product costs, purchases, etc) and $140m in long term debt (the money borrowed above). Not exactly a lot of net cash on hand to pay the existing bills and then run the 2010 operations.

When you look at all the numbers, and you add to that the complexity of the business, the risk factors (their S-1 lists 24 pages of them!) in the technology and the marketplace, then on a pure business analysis you have to agree with the auditors - they are not a going concern. It's also not unusual for a Silicon Valley early stage company (and it is still very early in the development of this technology and it's market) to be in this position. In fact, that's exactly why they need an IPO - to raise the money for growth and to get to cash flow positive from operations. But its pretty unusual for a company to take the step they just did - publishing an open letter to their customers and suppliers to explain why, in their view, this is not a problem.

To take a closer look at their SEC filing, click here.

I'm rooting for this company. It's in the forefront of developing new energy solutions we desperately need. They claim that "by the end of 2012, we will be able to deliver photovoltaic systems that produce electricity on commercial rooftops at rates that are competitive with the retail price of electricity in key markets on a non-subsidized basis". I'd love to see that! They employ 800 people, mostly in the Valley. Many of those people are in manufacturing - a segment hard hit since 2000. That number will increase with their second plant and further production ramp up. This is the kind of business the Valley needs, and needs to be successful. And the country needs the technology.

Still, a lot of people will have to make some pretty big bets to pull this off!

Let's Hear It For IPO's!

In one of my posts back in December I suggested the Valley might be in for an IPO boom. This is based largely on comments from a partner friend of mine at PriceWaterhouse Coopers who told me that perhaps 40 companies were lining up to file their registration statements with the SEC.

Well, my friends at Pacific Crest Securities [a terrific investment bank for whom I have the highest regard] showed us an update on this at their annual Emerging Technologies Summit last week. They noted that the backlog of IPOs and registration has increased by 3x in the last six months - from 12 in September to 36 at the end of last month! Those 36 are pretty equally split between Semiconductor, Software, Internet, Clean Tech and Communications.

They believe that the trend of IPO pricings [the actual completion of the process] should accelerate into Q2 2010, and that it might indeed be the start of a longer-term revival in the IPO market. They base this on the four key themes -  improving macro economic conditions; increasing strength of capital markets; a growing appetite among investors for a new "position" stocks, and the overall quality and robustness of the companies emerging in the market. This last one is very interesting because unlike many previous IPO booms [including, of course, the bubble in 2000] the companies we're seeing out there now are substantial, profitable businesses already. And we haven't even seen some of the potential megastars [Facebook and Twitter IPO's in 2010, anyone?] yet.

One other interesting stat. While there weren't many tech IPOs in 2009 [18, up from seven in 2008 but well below the 46 to 76 in each of the prior four years] the average performance of those 18 has been a 22% gain since pricing. By the way, just to give you a sense of the substance of those companies going public, the average revenues expected in 2010 from each of those 18 companies is almost $400 million, up almost 25% from 2009, and average earnings before taxes of $110 million. These companies have substance!!

The implications? Well, as I said before, the trickle-down effect in the Valley is enormous. From the sighs of relief from the VCs who, with liquidity events, can report improve returns to their investors and start their fundraising processes again [remember in that prior post of mine mentioned above, we noted that 54% of VCs said that the lack of exit's/liquidity events was their biggest worry] AND start funding some worthy startups again, to the prospects for employment [Valley unemployment continues to hover around 11%] to the injection of proceeds from stock option exercises and employee stock sales into our local economy.

Let's hear it for IPOs!!

IPO Boom Coming to the Valley ....!!

A friend of mine who is a partner at one of the Big 4 public accounting firms tells me that there are perhaps forty Silicon Valley venture-backed technology companies lining up to file for their IPO's. By "lining up to file" he means these companies have selected their investment bankers and other advisers and have at least held their "organizational meeting" - this is the formal kick off to the process. The first visible public step is the filing of the company's registration statement (the "S-1") with the SEC, usually a month or so after the org meeting.

As if to prove the point one of these filed last week - Financial Engines out of Palo Alto, looking to raise $100m to finance growth at their $50m annual revenue business. If you want to keep an eye on these companies and see who's filed, who's about to price (actually start trading) and so on then go to Hoover's free site (you can also sign up for their weekly email update).

Forty is a phenomenal number and, if these companies complete the process which itself may take a couple of months or more, indicates a boom IPO period in the first half of next year. In context, in 2008 there were only 6 venture-backed IPO's and only 8 through Q3 in 2009. What's more, many (but not all) are substantial businesses, profitable and high caliber.

Some will not complete the process. Many "dual-track", meaning they are using the IPO process to also bring potential acquirers out of the woodwork looking to buy the business before it gets too expensive as a public company. Others will fall by the wayside for various reasons, including probably those who will find the deluge results in investor fatigue. And all this of course assumes the market really has sufficient capital ready to pile in (more correctly, this is a psychological rather than physical hurdle)

But lets suppose the majority do complete the process. What are the implications? Well, some of the capital raised certainly makes it's way back into the startup ecosystem via angels, VC's and others. Some of it will percolate back into the broader Valley economy - buying houses, cars and so on. And - most importantly from my point of view - there will be a substantial change in the philosophy of the typical venture investor. Remember my post of July 9th? Silicon Alley Insider had just published a report that noted that the thing that worried most VC's was "Exit Markets - when will they return?"

Well, suddenly the entire picture changes, doesn't it? What you can be pretty sure of is that if there is a barrage of exits then the investor mood will shift dramatically - and hopefully in favour of substantially increased investment in Valley startups! We can certainly hope so!

 

IDC's Top 10 Predictions for 2010

Yes, it's that time of year again. Prognostications and predictions from "experts" all over the world and, my guess, most of them will be saying how next year will be better than this. Er, I guess that's also a prediction! One thing I think will be true - a burst of tech IPO's in the first few months of 2010 unless the markets tank big time. A post coming up on that.

I was able to get a copy of IDC's predictions for technology in 2010 today and I'll reproduce their summary (in italics) below. High level, very general. But sets the tone for a more positive and highly interesting year, I think. All of them augur well for Silicon Valley, one way or another.

"2010 will be a year of modest recovery for the IT and telecommunications industries. But the recovery will not mean a return to the pre-recession status quo. Rather, we'll see a radically transforming marketplace — driven by surging demand in emerging markets, growing impact from the cloud services model, an explosion of mobile devices and applications, and the continuing rollout of higher-speed networks. These transformational forces will drive key players to redefine themselves and their
offerings and will spark lots of M&A activity.

1. Growth will return to the IT industry in 2010. We predict 3.2% growth for the year, returning the industry to 2008 spending levels of about $1.5 trillion.
2. 2010 will also see improved growth and stability in the worldwide telecommunications market, with worldwide spending predicted to increase 3%.
   
3. Emerging markets will lead the IT recovery, with BRIC countries growing 8–13%.
4. Cloud computing will expand and mature as we see a strategic battle for cloud platform leadership, new public cloud hot spots, private cloud offerings, cloud appliances, and offerings that bridge public and private clouds.
5. It will be a watershed year in the ascension of mobile devices as strategic platforms for commercial and enterprise developers as over 1 billion access the Internet, iPhone apps triple, Android apps quintuple, and Apple's "iPad" arrives.
6. Public networks — more important than ever — will continue their aggressive evolution to fiber and 3G and 4G wireless. 4G will be overhyped, more wireless networks will become "invisible," and the FCC will regulate over-the-top VoIP.
   
7. Business applications will undergo a fundamental transformation — fusing business applications with social/collaboration software and analytics into a new generation of "socialytic" apps, challenging current market leaders.
8. Rising energy costs and pressure from the Copenhagen Climate Change Conference will make sustainability a source of renewed opportunity for the IT industry in 2010. 
9. Other industries will come out of the recession with a transformation agenda and look to IT as an increasingly important lever for these initiatives. Smart meters and electronic medical records will hit important adoption levels.
10. The IT industry's transformations will drive a frenetic pace of M&A activity."

For a full copy of the report you can register with IDC and download here

Life Returning to the Tech IPO Market?

In my blog on July 9th I talked about the recent survey focused on what worries VC's the most. Given that the answer, overwhelmingly, was "exits" (or rather, lack of them) its interesting to look at what's happened in the one month since my post.

In that period NASDAQ, the broadest indicator of tech market health, has gone from 1,756 to 1,992, or back to early October 2008 levels. That's an increase of 13% in one month. More focused tech indexes have done even better. Just as importantly it continues an improvement in the markets starting back in early March - NASDAQ bottomed at 1,268 and is now up 57% since then.

There are a surprising number of tech companies that are substantial, fast-growing, profitable (or on their way to being) yet are still private. You can see them in numerous tech segments - equipment, internet, software etc. These are the ones that need to spring loose in the public markets and now is the time to start seeing some of them do it. Filing an IPO this month means a good chance of completing the process before the holiday season and hopefully taking advantage of recent market strength.

And its starting to happen. Today, Fortinet filed their S-1. (An S-1 is the basic IPO prospectus or offering document filed with the SEC at the start of the IPO process.) They're a manufacturer of network security appliances (an "appliance" in this context is a simple, server-type box where the core functionality is in the software rather than the hardware - the hardware is simply the container, if you will) that reported over $200m in revenues last year, up about 25% over the prior year, and was slightly profitable. This is the type of low risk, solid, easy to digest IPO that will do well in this market.

Also last week Ancestry.com, an internet company, filed it's S-1. Their mission is to "help everyone discover, preserve and share their family history". Now I'm one of those sceptics who wonders how this can possibly be a big business. Apparently I'm wrong because it did $197m in revenues last year - up from $166m the year before! They're not a Valley company, and in fact they've been around in some form or another for 20 years, but they are an interesting filing to follow as an internet play.

Two other tech IPO's priced (that is, they completed the IPO process) in the U.S. last week - Avago, the Singapore-based former semiconductor group of Avaya, the HP spin off some years ago, and CDC software our of Hong Kong. Both are substantial, particularly Avago with $1.7Bn in sales last year.

More importantly, for our purposes, I hope these are the first of the next wave of tech-related IPO's that will provide exits (or will develop warchests to acquire some of the promising start-ups out there), and therefore hope for future liquidity events from today's investments, and slowly increase the confidence in funding some of the good ideas out there.

Yet More on the State of VC Funding ...

I hate to keep harping on VC funding, yet its still the lubricant the Valley relies on to help turn ideas into substantial businesses. The market is crying out for alternatives but for now its still the main game in town.

Because my focus is on Silicon Valley itself - more broadly, technology in the greater San Francisco Bay Area (so, yes, including San Francisco's South of Market start-ups, Emeryville and so on) - I'm always interested to see how the money flows to the Valley compared to other geographies. Here's Q2 2009 VC funding of start-ups by region, courtesy of Silicon Alley Insider (as are the other charts in this post)

The Valley continues to be the main recipient of VC funding, with one third of the total. Frankly, I'd expected it to be more. You can certainly see how the rest of the market is very fragmented, geographically.

In Q2 the industry segments that did best were biotech and medical devices, whereas clean tech has collapsed from a funding perspective (the Industrial/Energy vertical below). No real surprise as energy prices are way below those of a year ago and its still a tough space to figure out winners and one that requires substantial capital resources for success.



In a recent post I talked about VC's main concerns around lack of exits, or ability to eventually find a liquidity event that actually realizes their investment. Here's a very graphic representation of the (lack of) IPO opportunities for liquidity. The chart doesn't include Q2 2009 in which I think there were 3 tech IPO's including OpenTable, but its still a collapse compared to the couple of prior years. It won't continue this way for ever and in my next post I'll suggest some reasons why ...

OpenTable IPO's - Signs of Life?

Image by arvindgrover via Flickr

OpenTable! Its not exactly a major technology play - though it is a service I use for almost all of my own restaurant reservations. But it is a venture-backed, Silicon Valley-based startup and potential bellwether for the state of the IPO market as a whole.

Its no secret that the IPO market has been dead in the water for some time, with just 3 companies going public in the last two quarters compared to an average of 61 each quarter in the prior 3 years. With OpenTable and SolarWinds both IPO'ing this week that's a total of 7 companies so far this quarter. 

More promising than an uptick in the number of IPO's is the initial performance of these two companies in the market. OpenTable's stock was up 59% on its first day, although shedding some of those gains by the end of the week. SolarWinds was up 10% on it's first day but ended the week a little below it's initial offering price.

May sound odd to suggest that its still a promising sign when a company trades slightly below its offering price but my rationale is that it suggests the IPO was well priced by the underwriters whereas the jump in the OpenTable price is an indicator that the underwriters of that deal in fact priced the shares too cheaply. Not to digress too much but the whole point of an IPO is to provide liquidity for the company and its existing investors - and they get whatever the offering price was, not whatever it trades at afterwards. Interesting to note that 3 institutional investors in OpenTable sold shares at the IPO. Usually an underwriter doesn't like this and typically even locks in investors, employees and management to an agreement not to sell stock for six months after the IPO (a "lock-up" agreement), the rationale being that investors selling at an IPO indicates lack of confidence in the business whose shares are being sold at IPO to other investors. In this case, my guess is that these investors desperately needed the earlier liquidity for other reasons than lack of confidence in the company - but now it looks like they also left money on the (open)table!

Given the traditional importance of IPO's as a key liquidity objective of Silicon Valley companies and investors and in the overall ecosystem of the Valley, some signs of life I hope! Will be interesting to see if other companies are now encouraged to follow suit ...