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A bi-weekly column with timely, relevant and possibly irreverent insight into the BC technology industry.

Something Ventured:
June 2, 2006

By Brent Holliday
Greenstone Venture Partners

Hope Your AIM Is True


“Sometimes I wish that I could stop you from talking
when I hear the silly things that you say…
Oh, Alison, my aim is true.
My aim is true.” – Elvis Costello, Alison

I’m sure you heard about Vonage’s recent IPO and how it fell flat on the NASDAQ.  The “bellwether” IPO that wasn’t.  More like a canary in a coal mine…  As I have said here before, the IPO market is important because it represents the biggest liquidity event for the earliest shareholders and venture funds in technology related companies.  Selling your company for $20M is nice for the founders, but makes little for the option holders and later investors.  Driving the company to be big enough for a NASDAQ listing is the Holy Grail… well, at least it used to be.  Now another stock market is getting hotter, London’s AIM exchange.   More on that in a minute.

The technology cycle is definitely on the positive slope of the sine wave.  Are we near the top again?  Hard to say with certainty… until you are on the downside of course.  The job market is very tight.  New start-ups are forming and hype cycles like Web 2.0 are fomenting optimism and talk of a new bubble.  The biggest driver for technology markets in the next two years, in my humble opinion, will be investment dollars… and lots of them.  Not VC dollars, but huge amounts of money sloshing around in private equity funds and hedge funds in the US, Europe and Asia.  This money (in the hundreds of billions) is finding a tight market in commodity driven deals, cyclical companies and other traditional markets.  Simply put: There is so much competition for investment, the prices have risen in traditional industries to the point where the “smart” folks at these funds will look elsewhere.  And look, technology is hot again… time to flood it with money.

Before you start drooling over the possibilities, one big caveat:  This money does not like the start-up.  It is after the cash flow positive company with proven customers and a good growth story.  It is also less patient than VC money and usually demands a control position in the company on one investment round (VCs tend to take a minority position on the first round, but layer the agreements with protections… so some of you cynics may be saying, what’s the difference?).  Another feature of this type of money is that the managers are financial engineers, not electrical engineers.  Which means they are less enamoured with the technology value proposition than they are with the structure of the deal and… wait for it… the quick exit path. 

How and when will these players get into the technology markets this time around?  Well, that brings me back to the AIM market in the UK.  Some early examples of success of IPOs on the AIM, at lower valuations than those that have attempted NASDAQ IPO filings, have energized the “masters of the universe” at private equity and hedge funds.  March Networks of Ottawa and Sandvine of Waterloo are the two recent examples of companies in Canada going to the AIM to go public.  Sandvine had revenue of $16M in 2005 ($3M in 2004) and a loss of $3M (all figures converted to CDN).  It raised $41M in its IPO and now sports a market capitalization of $270M (for those of you keeping score at home, that is almost 17x trailing 12 months of revenue).  March Networks listed concurrently on the TSX and AIM in April 2005 and had trailing twelve months revenue of about $35M.  It now has about $75M in annual revenue and sports a market cap of $414M on AIM.  In terms of raising more money, InterMap Technologies out of Calgary (already on the TSX) is doing a secondary on AIM this month. {Why not the big TSX exchange, you ask?  The listing requirements for the main TSX are more stringent than AIM.  And some feel that the TSX is not technology friendly, despite protestations otherwise from them.} 

If NASDAQ is the big daddy of technology exchanges and the TSX Venture is the seed/start-up exchange, then AIM is the adolescent.  You have to be somewhat mature to go public on AIM, but you don’t need to be all grown up.  Sarbanes-Oxley is a huge regulatory headache of the US exchanges which can be avoided with AIM.  Liquidity is not a problem on AIM as it trades over 600M shares daily across 1,500 companies.  Since it looks like candidates for IPO are in the >$70M market capitalization range, earlier stage companies can make the jump as Sandvine did with only $16M in revenue… but note the growth of their revenue.  Local companies doing $10M CDN in revenue and are profitable might start to see if they qualify.

The financial engineers will also try to jam smaller companies together to form a bigger whole that meets the minimum requirements for an AIM listing.  While this process of merging small companies can work with careful strategic thought, the creative rationalization of why a Java-based software tool company fits with a .Net vertical software as a service application company will likely be driven more by the quick flip onto the AIM and liquidity for the new investors than any long term strategic thinking.  This may sound stupid, but it is the inevitable result of too much money looking for quicker and higher returns.  And it is coming… in fact, it is likely already here.

The other effect of the new money in technology will be the rise in valuations given to technology companies that are profitable and growing.  In fact, it may be that the start-up has a harder and harder time getting money to get to profitability, but then gets a huge step-up in the pre-IPO round of financing.  Remember, these financial engineers will work some clever deals.  It will entirely be possible to see founders and earlier investors sell some of their positions on these rounds before the IPO. 

Big money with no technology domain experience taking pre-IPO financings… hmmm, sounds familiar.  Remember this happened in 1996-1998 at the front end of the last bubble… Bigger and bigger amounts started to be invested in earlier, bolder companies until the big private equity players were funding raw start-ups to take advantage of the new Telecommunications Act in the US.  Who remembers the CLECs?  Hundreds of millions of dollars were invested per company to try to unseat the existing phone companies.  Many billions were lost and private equity went away from technology for a few years.

The AIM market is not a panacea.  It will be hard to list a smallish company on the exchange and as more and more companies list, the ability to generate investor interest inevitably diminishes.  But the discussion among IPO starved investors has hit a fever pitch.  And the big boys are smelling some quick money.  The difference this time is that the bubble may be predicated on companies with customers, revenue and profit, as opposed to the last bubble where those small details were overlooked at IPO time.  Bottom line, once again, is that you have to build a company that can generate tens of millions of dollars in revenue and be profitable in order to hit the IPO jackpot.  The AIM exchange has just opened the door to an earlier IPO and could/will mean a rush of money from the private equity/hedge fund to the technology companies that hold that potential.

This oughtta be fun.

What Do You Think? Talk Back To Brent Holliday


Something Ventured
is a bi-weekly column designed to supplement the T-Net British Columbia web site with some timely, relevant and possibly irreverent insight into the industry. I hope to share some of the perspective and trends that I see in my role as a VC. The column is always followed by feedback (if its positive or constructive. I'll keep the flames to myself, thanks).

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