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Where Are the IPOs?

Column
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8/31/2006

Whither Force10 Networks Inc. ? Where's BigBand Networks Inc. (Nasdaq: BBND)? What about Riverbed Technology Inc. (Nasdaq: RVBD)?

All of these networking companies were expected to stage IPOs in either 2005 or 2006 (next, 2007) – and yes, we helped contribute to the hype. But none of their S-1 filings are in sight. (See Force10 IPO Still Hanging, Riding the Cable Consolidation Wave , and Riverbed Scales Up.) The networking IPO has become a rare, exotic bird. And the one big telecom IPO we have to point to – Vonage Holdings Corp. (NYSE: VG) – looks quite ill. Will the tech IPO ever come back or has it flown south for eternity?

You can blame a lot of it on a soft Nasdaq , and eroding technology valuations in general. The Nasdaq is down about 1 percent for the year, while the S&P 500 is just about treading water.

But many of you may choose to blame the least popular legislation in Silicon Valley and on Wall Street: Sarbanes-Oxley. This was the piece of legislation that was supposed to "fix" everything that went wrong in the bubble. But a "government fix" is an oxymoron, so it should come as no suprise that this legislation has become one giant mess.

Sarbanes-Oxley has single-handedly ground down the pace of development for young technology companies by saddling them with an endless stream of bureaucratic costs. It's threatening to move most tech IPOs offshore. And is it cutting down on corruption? I doubt it.

"It's just dumb," says Rod Randall, who is senior managing director with Vesbridge Partners LLC . He estimates that Sarbanes Oxley costs a private company about $2 million to $5 million in preparation to go public. That's a direct hit off of profit – which would result in a $60 million to $150 million haircut off the company's public-market valuation if it were to go public, as he explains it.

Imagine this: You are a maturing venture-funded startup. You survived three years of technology depression. After many years of cutting, down-rounds, and new product development, you're finally close to breakeven now. You're on your fourth gray-haired CEO, and this guy actually seems to get it. You've got almost $100 million in revenue. But you have prepared to go public, and now you won't make any money. Why? Because Sarbanes Oxley has just added another $3 million in additional costs. That's your first year's profit – handed directly over to the regulators.

"Sarbanes Oxley was an overreaction to the aftermath of the Insanity.com era," says John Fitzgibbon Jr., the founder of IPOscoop.com . "It's added a lot of expenses onto these companies. The extra can chew up your bottom line completely. There are companies that are already trading public that have decided that it's better to go private."

"For a tech startup trying to make its first million in profit, to just give it away to Mr. Sarbanes and Mr. Oxley, that's crazy," says Vesbridge's Randall.



Chuck Gershman, the CEO of Bay Microsystems Inc. , one private company that could be a technology IPO, agrees that Sarbanes-Oxley does present a "high hurdle" for a company looking at IPO. He says his company has hired consultants and professionals to look at the the issues, and estimates the cost at $2 million to $4 million.

"It's certainly a topic that we are painfully aware of," he says. "It's a fixed cost in your G&A expenses. It's going to reduce your net profit any way your slice it."

Would Sarbanes Oxley by itself stop a company from going public?

"Sarbanes Oxley is a component of IPOs," says Gershman. "It is one of the reasons the IPO market is not good... but it's a soft market as well. Sarbanes Oxley is not a positive influence." So what to do about it? Well some companies have gone offshore. Sandvine Inc. and Newport Networks plc (London: NNG) staged IPOs on the U.K.'s Alternative Investment Market (AIM), which is emerging as a big competitor to Nasdaq for smaller technology IPOs. On AIM, the reporting requirements are much less strict, and the costs to go public are a fraction of what they are on the Nasdaq. (See Session Controller IPO Scores Success, Sandvine AIMs for IPO, Sandvine Leaps on London Listing).

"To go public on AIM would cost $300,000 to $400,000 per year," says Gershman. "We've investigated this. And the bankers are pitching it."

It's a trend that recently led Hank Greenberg, the CEO of AIG, one of the largest insurance companies in the world, to write in The Wall Street Journal that Sarbanes Oxley may be having the effect of diminishing the competitive advantage of the U.S. capital markets. In the technology world, at least, it certainly looks that way.

First the United States outsourced the technology, then the IPOs. What next? Perhaps the founders and venture capitalists themselves.

Sarbanes-Oxley should be killed. Unfortunately, that doesn't look likely to happen. In the meantime, get used to fewer exits – and a lot more action on the AIM.

— R. Scott Raynovich, Editor in Chief, Light Reading

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Michael Harris
Michael Harris
12/5/2012 | 3:42:08 AM
re: Where Are the IPOs?
"Sarbanes Oxley is a component of IPOs," says Gershman. "It is one of the reasons the IPO market is not good... but it's a soft market as well. Sarbanes Oxley is not a positive influence."

Maybe there's a start-up opportunity for a company that helps start-ups more efficiently meet Sarbanes Oxley requirements. They can prove the model by completing their own low-cost NASDAQ IPO. VCs, get busy on this one if you want to see some liquidity events. ;)

So what to do about it? Well some companies have gone offshore. Sandvine Inc. (London: SAND - message board) and Newport Networks Ltd. (London: NNG - message board) staged IPOs on the U.K.'s Alternative Investment Market (AIM), which is emerging as a big competitor to Nasdaq for smaller technology IPOs. On AIM, the reporting requirements are much less strict, and the costs to go public are a fraction of what they are on the Nasdaq.

There's another major benefit to the London AIM: investors who hold shares for at least three years can avoid the long-term capital gains tax on stock profits seen in the U.S.
paolo.franzoi
paolo.franzoi
12/5/2012 | 3:42:06 AM
re: Where Are the IPOs?

Sox 404 is an overhead of an ongoing business. To me it is like ISO 9000. You can choose to run your business and do it or you can organize your business around it.

The way to make Sox 404 simpler is to organize your business from the beginning to embrace it. Then meeting Sox is simply normal business. Now the problem with this statement is that it would cause added cost and headcount to a startup at the beginning.

seven
optoslob
optoslob
12/5/2012 | 3:41:41 AM
re: Where Are the IPOs?
Seven, I can't believe you wrote this dribble. Repeat after me "SBO is a complete POS" now keep repeating until you get it right.

SBO is the ultimate GÇ£turd in the punchbowlGÇ¥, it does absolutely nothing to enhance the understandability of the accounts or operations for companies in a fast changing environment. (think IPO) as a matter of fact it has exactly the opposite effect, especially if a significant number of warrants and stock options exist.

If you want to see SBO at it's worst look at any tech company that needs a little extra cash and goes to the PIPE. Lets assume warrants are issued along with the loan. Now for a lesson in SBO silliness look at the accounts pre and post PIPE.
Tell me which one gives better visibility to the real operations and "cash flow" requirements for the company.

In Asia most of the tech companies that would have considered Nasdaq listing are instead listing on the Hong Kong exchange.

optoslob

repeat
"SBO is a POS"
"SBO is a POS"
"SBO is a POS"
"SBO is a POS"
paolo.franzoi
paolo.franzoi
12/5/2012 | 3:41:41 AM
re: Where Are the IPOs?
opto,

Perhaps that is because something moving as fast as you are describing has no business being taken to an IPO?

Finances that unstable do not make an investment. They make Las Vegas.

seven
optoslob
optoslob
12/5/2012 | 3:41:38 AM
re: Where Are the IPOs?
Seven,
I thought that you had worked at a start_up. The whole game is getting the job done in half the time it should take with 1/4 the resources you really need and grow grow grow. By its very nature a startup is not a stable investment, however stable investments do not deliver 100% per year growth rates, which is exactly what investors want to buy into.

All that SBO adds in this environment is a Turd right in the middle of the punchbowl. Everyone knows the SBO turd needs to be there BUT its is hard these days to interest investors in your IPO when the first thing they see is all this SBO crap.

Yes, startups are the Las Vegas of engineering, engineers gamble their time and skills investors gamble with money and less than 1 in 10 really makes it big. Investors that believe SBO brings anything to the party need to get back into Mutual Funds quickly, or stick with utilities.

optoslob
zoinks!
zoinks!
12/5/2012 | 3:41:32 AM
re: Where Are the IPOs?
Is SBO yet another reason for US VCs to continue to increase funding in startups based in Asia, specifically India and get out of the US market altogether? Or is there no relation?

Seems to me it gives the greedy, I mean innovation driven, VCs yet another reason to bail on the US...

... or maybe I'm just too cynical and paranoid.

zoinks!
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