Investors should not be wary of VC-backed tech
The ‘campaign’ to kickstart the London tech IPO market is underway. The blog posts that Neil Rimer and I both published have attracted a lot of press attention. The engagement we’ve had with No10 and the LSE should result in some small but important regulatory changes that should be seen as important steps towards making London a major hub for tech IPOs.
As we have consistently said, however, regulation is not the primary barrier to a robust IPO market. A number of other parts of the ecosystem need to evolve simultaneously. Over the past month, I've heard a number of concerns that Europe’s public markets are not ready for international tech companies.
Below I list a number of the specific concerns and, where relevant, address them. The main takeaway, to my mind, is that institutional investors should not be wary of venture-backed tech companies—indeed, they should seize on the opportunity to learn more about and invest in this space, a rare ray of light in an otherwise gloomy economy.
1. How good are the governance structures and procedures?
Companies that are backed by venture capital firms have strong governance built in from their first investment, which is typically a Series A funding round. Formal board meetings are held, usually monthly. Compensation and Audit committees are commonly set up and meet at least annually. Key decisions will normally need Investor Director approval or shareholder approval. The governance rules are set out in the companies articles and shareholders agreement. By the time the typical fast growth technology company is ready to come to the market, governance would have been refined and tightened. Good governance is in the DNA.
2. Are there dominant shareholders, directors or founders who run the company?
Tech companies seeking IPO will typically not have any controlling shareholder. All preference shares would be converted to common stock. The founders will generally own less than 50% and there will be at least 2 VCs, often 4 or more. The company will typically have little or no debt. Venture backed companies are, by nature, equity funded. The distinction between this and the typical PE backed company could not be clearer?
3. How difficult will it be for founders to adapt to life running a public company?
Clearly this is a challenge for founders who have never been in that position before. But these challenges will not be those of being accountable to a board or shareholders. Founder/CEOs and CFOs will have raised multiple rounds of finance, involving many detailed presentations to investment committees and will have been required to take investors through detailed accounts, budgets and 3 - 5 year plans. Missing quarterly targets cause real consternation and are frequently damaging to valuations achieved at funding rounds - so managing expectations and getting forecasts right are very important.
4. Won’t share prices be volatile if market capitalisation is low and only 10% of a company is floated?
This is undoubtedly true and will probably eliminate many investors from the share register – at least at floatation. Since a number of the early shareholders (Seed, Series A, Employees) will want to exit at some time in the subsequent year or 2, the float will inevitably rise and opportunities to build stakes will present themselves.
The initial low float should not be a reason for a company not to be listed.
5. Is the floatation designed to allow founders and other shareholders a quick exit?
The main reason for our pushing for the minimum float rule to be reduced from 25% to 10% is to align founders’ longer-term interests with incoming investors in terms of floatation price. 25% dilution is a large one for a founder to take whose business is growing at more than 50% per annum. It feels more like 'selling out' than another funding round on the road to building a large successful company.
VCs and other early stage investors will undoubtedly wish to exit over time and a consistent strong performance from the company will facilitate this.
6. Are there really enough suitable tech IPO candidates in Europe?
Quoting from Neil's blog post that kicked off this whole debate:
"We’ve seen over the past few years how most of the successful exits by European companies in our portfolio have been trade sales (MySQL, Skype, Playfish, Lovefilm, Net-a-Porter, Last.fm, PanGenetics, etc.) while only a few went public (Genmab, Betfair, Asos, Addex). We hope the future will tell a different story however. At the Index Ventures annual meeting last week, we presented some data to our LPs (yes, VCs have investors too) that reminded us of the depth of the value pool in Europe. We counted 20 companies (Criteo, Adconion, Photobox, Moleskine, JustEat, King, to name a few) born in Europe, that are at or fast approaching a point of being IPO-ready. "
Just looking at the Tech Track 100, published by the Sunday Times, we see that the 100 fastest growing tech companies in the UK:
- had average growth from 2010 to 2011 of 81%
- had Total Revenues of £2.7bn (what will the total be in 2012?)
- Employ 11,000 people (adding 7500 in the year)
- 75% of them had operating profits - as well as rapid growth
- 51 companies are still majority owned by their founders
- 40 are backed by VCs (6 by TAG and Index) or PE firms
The tech IPO market in the US is heating up again - post the Facebook debacle. It really is time to get the first steps taken here in Europe!