Heading for the Exits? Shoot for an Acquisition, Not an IPO

Allegis Capital conducted its annual Limited Partners meeting May 12 and 13th in Half Moon Bay, Calif. We do this every year to allow our investors a chance to meet and greet our CEOs and see how their companies are progressing. We also want our CEOs to have a chance to network with the people who funded their dreams including us and our limited partners. During the two days, one day is devoted to our CEOs presenting their companies and the other day we use the time to discuss topics that can benefit our CEO’s learning.

In our day devoted to learning, one panel delved into the outlook for the IPO and M&A markets. Our speakers were Jamie Montgomery, the CEO of Montgomery & Co., Tom Shanahan, head of west coast banking at Needham & Co. and Brewer Stone, former managing director of FBR Capital Markets in San Francisco.

A key message was that acquisitions can be viable alternatives to an IPO exit – particularly in the current market environment. This strategy has always been a key strategic mandate at Allegis Capital. It was interesting to hear it supported by investment bankers whose vested interest, if any, I would assume would be to encourage entrepreneurs to “shoot for the moon” via a public offering instead.

But nobody could refute the numbers in the last decade, and none of them tried.  Years ago, in the early to mid 1980s, as many as 97 percent of venture-backed startups went on to go public. That’s ancient history, however. Between 1998 and 2008, the number of startups that went public annually plummeted from a high of 20 percent to a low of almost zero. At the same time, the median age of a startup that managed to go public increased from four years in the early ‘80s to about 10 years by 2008.

Two additional figures were cited and are worth highlighting. Over decades, the average number of companies funded annually by U.S. venture capitalists is 883. By comparison, the average number of IPOs annually has been 85, or less than 10 percent of the number of companies funded.

During the panel discussion, Jamie Montgomery, CEO of Montgomery & Co., noted that acquisitions of venture-backed companies have always been strong — about 450 a year, on average. This year, Montgomery predicted the number will be even higher – 450 to 600 – and then soar to 750 to 900 in 2011, twice the peak between 2005 and 2007. “I still think 95 percent of venture-backed exits will be M&A transactions over the next five years,” Montgomery said.

This ties together with what we have seen at Allegis over the past 15 years – 98% of our returns have been from M&A exits.

M&A has always been an instrumental part of our strategy and we have seen IPO-like exits with a number of our companies, including IronPort Systems, Rent.com, Shopzilla, to name a few.

Today, conditions are ripe for startups to attract strategic buyers. There has been a fundamental shift around innovation in America and it favors smaller companies over the larger, more established.   Large technology companies are sitting on the strongest balance sheets in their history and their new product cupboards have grown bare at a time when demand is increasing. Small wonder, then, that Robert W. Baird & Co. recently reported a 93 percent increase in U.S. middle market M&A transactions in March – the largest monthly deal count since June 2000.

This isn’t to say that smaller IPOs aren’t still doable. Tom Shanahan, the head of West Coast banking for Needham & Co., told our limited partners that startups have a shot if they have at least $50 million in annual revenues, are relatively close to profitability, and have very high short-term visibility. Needless to say, however, their odds of success to get their company “banked” are still poor, largely because most investment bankers won’t touch such small deals today. That’s why we need to create the 2010 version of the four horsemen: Alex Brown, Robertson Stephens, Hambrecht & Quist and Montgomery Securities in order to restore the venture ecosystem to its former health.  Montgomery and Needham are two of my nominations to fill the void.

Another interesting point according to Jamie Montgomery, a lot of startup CEOs no longer care whether they ultimately head a public company or not. If they avoid an IPO, they avoid what he called “bonehead” quarterly Wall Street conference calls, and to understand that many public companies don’t ultimately fare well. This is one reason why the number of public companies listed on U.S. markets has declined 40 percent since 1997 while this number has increased in most other countries, often substantially.

While we can’t invite the public to our LP meetings, we can certainly bring some of that meeting to you.  Check out the “Heading for the Exits” panel session on our website.

Bob Ackerman is the founder and managing director of Allegis Capital (www.allegiscapital.com), a seed and early-stage venture firm headquartered in Palo Alto, California. Ackerman has worked with more than 50 corporate investment partners over the past 20 years as both a venture capitalist and a startup executive. Read his past peHUB posts here