Insights and Opinions

By the Numbers: The Returns from Southern California IT IPO's 1995-2009

On March 10, profiled a study of the financial outcomes of 700+ southern California IT startups from 1995-2009 completed by Jon Funk of OceanRoad Partners and others. This Insights and Opinions column by Jon is the first in an occasional series delving deeper into the data. Corrections and contributions are welcome.

One of the numbers most interesting to venture capital firms, their investors and other observers is how successful Initial Public Offerings are for venture capital firms and others which invest prior to an IPO.

In an effort to address this issue, we have created a simple arithmetic calculation to determine a proxy value for potential returns to private shareholders in companies that complete an Initial Public Offering. This approach can be used to hypothesize the scale of return available at the time liquidity is available. We have applied this methodology to the 67 IPO's completed from 1995-2009 by southern California venture capital-backed and self-financed IT companies.

Initial Public Offerings are an event that can lead to liquidity for private investors in emerging companies. However, senior management and large private shareholders, which usually include venture capital investors, are nearly always precluded from selling a material portion of their holdings until six months after the IPO is completed.

Shareholders with the opportunity to sell six months after the offering are usually considering a substantially different value of their holdings as compared to the first day of trading. Further, in the following months, each investor makes individual sale decisions based on its own objectives, guidelines and assessment of the company's prospects. Thus, knowing how potentially successful a given investment upon completion of an IPO is for its previously-private shareholders is virtually impossible to determine.

Using publicly-available share trading date, the market capitalizations of each of the 67 companies that completed an IPO from 1995-2009 have been calculated as of the close of the first day of trading, and also at the 180-day, 270-day and 360-day marks. We averaged the capitalizations for the three latter points to provide a proxy value for investors able to liquidate their holdings after the assumed six-month lockup has expired.

From 1995-1998 (for the purposes of this discussion, "pre-bubble"), 27 companies, or an average of about seven companies a year, completed an IPO. In 1999 and 2000 ("the bubble"), 25 companies, or about 12 per year in that two year period, went public. From 2001-2009, as public technology values collapsed, recovered and then collapsed again ("post-bubble"), 15 IPO's were completed, as the average fell to less than two per year over the nine-year period.

Let's look a little more closely at 1995-1998, the first interval covered by our data.

1995-1998 is generally considered a time in which venture capital industry was more or less in a state of equilibrium. Investment capital was plentiful but not over-abundant. The internet was beginning to appear as a brand-new technology platform. Communications, networking, software and semiconductors were vibrant categories. Until the second half of 1998, public markets were receptive to IPO's, but not overeager.

On average, the market capitalization of a company that completed its IPO in this period was $338 million at the close of the first day of trading. Our proxy value for the 27 IPO's for this period gives us an average increase in market capitalization of to $596 million, or 76%. Thus private investors had the opportunity to cash out of their public companies at investment returns that improved substantially in the public market.

It should be noted that data for this period is skewed upward by data from the second half of 1998, as three internet startups, Geocities, and Ticketmaster Online-CitySearch, completed their IPO's. The cumulative value of these three companies as of the close of trading on the first day totaled $3.4 billion, and our proxy calculations yields a combined value over the period 6-12 months later of $9.5 billion, or a near 3x additional total return. Yahoo eventually bought Geocities and (which then gave Mark Cuban to the NBA, to its frequent regret).

Setting aside these supersized values, the remaining 24 startups averaged IPO values of $240 million and proxy values of $316 million, a more modest but still rewarding 32% increase.

Noteworthy other successes in this group include Xylan (proxy value-$1.2 billion), Broadcom ($803 million), Star Telecommunications ($729 million), Cymer Laser ($678 million), Applied Micro Circuits ($577 million) and HNC Software ($473 million).

But with the debut of the three internet offerings in late 1998, each at over $1 billion, the bubble was clearly inflating.

In future posts we will review the interesting patterns created by the bubble (1999-2000) and its aftermath (2001-2009) for the 40 southern California IT startups that went public in those periods.

Jon Funk has been directing Series A investments in emerging information technology companies in Southern California for over 25 years. He has been a Managing Director with Allegis Capital since its founding in 1996. Jon's Allegis Capital investments include Sandpiper Networks, and Shopzilla. He currently on the Boards of Staccato Communications and ClariPhy Communications. Jon wishes to thank Beth Fairchok for her diligent and accurate research supporting the data and calculations used in the article.