Since 2008, the initial public offering market for tech startups in the U.S. has been pretty dead. In 2010, 42 tech companies went public, compared to 17 the year before. But that pace is slow compared to past boom years.
Many of the IPOs are Chinese or Indian tech companies coming into the U.S. stock market. Of the tech companies that have gone public, only six U.S. firms are in the category of digital media and internet. IPOs are no longer the option they once were for smaller or mid-size tech startups, said David Liu, a managing director for digital media and internet deals at investment bank Jefferies & Co., speaking today at the Digital Life Design conference in Munich today.
The state of affairs raises an interesting question: Is there a bubble in tech valuations for companies such as Facebook, even though there is no accompanying frenzy around IPOs? The question is critical to tech companies of all kinds, since the ability to cash out is so important in the innovation cycle. It helps employees get rich, lets investors get a return so they can invest in new companies, and it allows big companies to buy smaller ones.
Some of the biggest potential candidates such as Facebook, LinkedIn, and Groupon aren’t going public because they’ve raised huge rounds from venture capitalists and private equity firms. That’s creating a mixed outlook for the valuation of tech companies. In the fourth quarter of 2008, the value of internet companies hit bottom, with shares trading on average at 6 times EBITDA (earning before income tax, depreciation and amortization). Now they are trading at 11 times EBITDA.
On the one hand, it’s kind of insane that Facebook can command a $70 billion market value, said Henry Blodget, panel moderator at DLD and editor in chief of Business Insider. That value is based on the recent trading in the secondary market created by Facebook’s recent investor, Goldman Sachs, which put $1.5 billion into Facebook. While Facebook isn’t public, its shares are traded on SecondMarket, which offers liquidity to employees who want to sell their shares in hot companies.
On the other hand, there is only one Facebook, Liu said.
SecondMarket, headed by panelist Barry Silbert, allows employees to cash out early by letting them sell shares to high-net-worth investors, who presumably know the risks they are undertaking of buying shares in a private company that does not yet release financial information. Through SecondMarket, lots of Facebook employees have sold shares, resulting in a price for the shares that allows observers to calculate Facebook’s current market value. Silbert say the benefit of secondary market trading — which is only about two years old — is that employees can cash out and relieve the pressure on the company to go public.
The attractiveness of this secondary trading is one of the factors that is causing a “slow death for the IPO,” Silbert said, compared to a decade ago. After the Facebook-Goldman Sachs deal was announced, most major banks reached out to SecondMarket to see how they could participate in the secondary market.
A decade ago, much smaller companies would go public because they didn’t have the secondary market option.
“Ten years ago, you could be a company that was valued at $150 million and go public on the IPO market,” Silbert said. “But today, it’s $500 million or it’s $1 billion. The companies that are getting out are these very large companies.”
Employees are thus impatient to unload shares, and some private investors are desperate to pour money into the hottest companies. SecondMarket takes a three percent to five percent cut from the seller. “In 2009, the first year we launched this market, we did 100 million dollars in private company transactions across about five companies,” Silbert said. “In 2010, we did $400 million across 40 companies.”
The Securities and Exchange Commission may crack down on this secondary market (especially if there is are tougher regulations passed), and that could force Facebook to go public, said Matthew Bishop, an editor at the Economist and a panelist. But the SEC is likely only to force Facebook to disclose its financial information.
Blodget said that he thinks Facebook will choose to stay private, in part because there are so many difficulties in going public, such as complying with the Sarbanes-Oxley regulatory law in the U.S. Bishop also said that the tough regulatory environment, which was implemented after the last bubble, is making it far tougher for companies to go public.
Parts of the tech start-up market seem overheated, in addition to the trading/investment in Facebook. Super angels are individual investors who have made a lot of money and have raised their own funds for further investment. Those angels have taken a “spray and pray” approach of investing in tons of tech startups, Bishop said. Also, as Google and Facebook spar for talent, they’re acquiring companies just to get their hands on good teams. That is inflating startup valuations too.
“This bubble is a different kind of baby,” Bishop said.
Silbert said that talk about bubbles simply sells newspapers. While the valuations of Facebook and Groupon are high, one could argue they are unique and disruptive companies, Silbert said.
“There are signs of life,” Liu said. “But it’s more like air pockets than a bubble. In some areas, there is too much euphoria, but in general, that’s not true.”
Liu said that foreign companies coming into the U.S. stock market could continue to do IPOs. And there are perhaps 30 to 40 U.S. tech companies waiting in the wings to go public — if the barriers to being a public company are somehow alleviated.
Even if tech companies wanted to go public, there is more to deter them. In 1970, shareholders hung on to shares for five years, on average, Silbert said. Now the average is three months. Part of the reason is that 60 percent of all trading now is done via computerized algorithms. So CEOs can’t really break through with a message that extends a couple of years out, since shareholders only care about the short-term outlook. IPO windows are also shorter, with stocks up one month and down the next.
“Volatility in the market is here to stay,” Liu said.
Blodget said that “people have been screaming about a bubble in Facebook’s value since it was $2 billion” and the value keeps getting higher. He joked, “Some day they will be right.” Meanwhile, SecondMarket is expanding to overseas markets such as Europe and Israel.
Disclosure: The Digital Life Design conference paid my way to Munich so I could moderate a panel. VentureBeat’s coverage of the conference remains objective and independent.
[pictured: from right to left, Henry Blodget, David Liu, Barry Silbert and Matthew Bishop] Check out a partial video of the panel below.
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