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