The IPO market roars back

By Eilene Zimmerman, contributing writer

( -- For promising companies looking for capital, the once-dead IPO market is becoming attractive again -- especially for those backed by investors eager to cash out.

In the last six months, 20 venture capital-backed companies have had IPOs. That's eight more than went public in all of 2009, according to the National Venture Capital Association.More than 40 more are in registration with the SEC, preparing to go public, and next week will bring a splashy debut from electric carmaker Tesla Motor Co.

It's a big change from recent years, when the IPO market -- especially for the tech companies VCs favor -- was essentially frozen. In 2008, just six venture-backed companies went public.

Investors say this year's flood of registrations is a sign of growing confidence in the economy. "We are feeling hopeful, especially because this market is very sane," says Jim Watson, managing general partner at CMEA Capital, a venture firm in San Francisco. He sees a backlog of established, profitable companies that have been biding their time until the IPO window opened again.

One of them was Fortinet (FTNT), a Silicon Valley company that provides network security solutions and filed for its first public offering last August. The company was almost 10 years old, had 120 employees, and had just turned a small profit on its most recent annual sales of $212 million. Venture capitalists have sunk $95 million into the business over the years.

"We wanted to succeed as an independent company and we needed to create some visibility. Going public was the way to do that," says Ken Goldman, Fortinet's CFO. He viewed the dry IPO market as an advantage: Fortinet could get out early and get attention from investors. It worked. The company went public on Nov. 18, raising $160 million for its working-capital stash. Fortinet's shares priced at $12.50 but immediately shot up to $17 when the market opened; they've traded in about that range ever since, fluctuating from a low of around $15 to a peak of just over $20.

For established companies seeking capital to fund further growth, there are often just two options: IPO or get bought.

That's what motivated Calix (CALX) to take the plunge, says CFO Kelyn Brannon. The Petaluma, Calif., maker of broadband networking systems went public in March. Founded in 1999, Calix has a staff of 400 and annual sales of $250 million. The company's previous funding rounds, totaling $100 million, came from venture capital and loans.

"We were the kind of company that could do that in the current market -- mature, with a large footprint and a leader in our space," Brannon says of her company's IPO. Calix's shares priced at $13, raising $54.2 million for the firm.

But Calix lacked one thing investors are eager to see right now: Profitability. The company had never turned an annual profit, and lost $12.9 million in the year preceding its public debt. In mid-June, the company's stock was down about 12% from its IPO price .

Overall, the ventures that went public during the recession have held up well. If you'd bought one share, at the IPO price, of every venture-backed company that has debuted since 2008, your portfolio would be up by about 13% today. In comparison, the Russell 2000, a small-cap stock index, is down 11% since the start of 2008. (Click here for a full list of recent IPOs.)

But there are some big flameouts in the mix. Biotech company Bioheart Inc (BHRT). went public on Nasdaq in February 2008 but got booted off the exchange a year later because its market capitalization had sunk below the required minimum. It now trades over the counter -- for around 50 cents a share.

On the flip side, there's companies like security software vendor ArcSight (ARST) and restaurant reservation system operator OpenTable (OPEN). They've steadily grown their market values and now trade for more than twice their IPO share price.

The companies that do best in public trading have a few things in common, says Christopher Austin, a partner specializing in capital markets at the law firm Goodwin Procter in Boston. "You definitely need strong revenue growth -- I think most companies really need between $60-$100 million a year in revenue -- and to be at least breaking even on a cash basis," he says.

Ironically, the improving IPO climate could also accelerate the M&A market.

"A buyer always wants to buy a company at the lowest price, and if they know you can't go public, they bid low," says CMEA Capital's Watson. Instead of taking lowball offers, companies with the resources to weather a dry spell generally prefer to tough it out.

Now, they may see better valuations than they would have a year or two ago. Austin says his clients -- mostly technology companies -- no longer feel they are at the mercy of buyers.

"We had clients recently get an offer of $130 million for their company. Then they talked to bankers about going public and found their valuation was more like $350 million. So you have a situation now where if a buyer really wants a company, they have to pay a premium," he says.

The recession has been brutal for small companies, but the silver lining is that it had a Darwinian effect: The companies left standing are the strongest. "That bodes well for any company moving forward, but especially one having an IPO," says Jeffrey Sohl, director of the Center for Venture Research at the University of New Hampshire.

In fact Jim Watson of CMEA Capital predicts that 2010 through 2020 is going to be one of the greatest decades ever for venture capital returns.

"The best entrepreneurs and the best companies will get funded. We're going back to where the money invested can be absorbed in a healthy manner. It's actually very similar to how it was in 1990. It's like, oh yes, I've seen this movie before," he says. "And it's a good one." To top of page

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