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Friday, August 24, 2001

Business Exit Strategies

The number of technology companies going public in the US is still way below its dot com peak, and many are now looking to alternative markets like London. That's good news for UK entrepreneurs

It's now six years since the dot com era got its first painful introduction to economic reality, and in many parts of Silicon Valley the memories of recession are fading fast. Today, home-grown Internet darlings like Google are once again driving the IT agenda. The hype factor is creeping back in the form of Web 2.0, the 'new generation' of collaborative Web initiatives. The housing market remains beyond the reach of most mere mortals, even in the midst of a market correction. And the future seems full of possibilities, with biotech, nanotech and clean tech all holding out the promise of great riches to come.

Nothing's ever perfect, however, and the good news has been offset by a couple of spectacular negatives. Silicon Valley icon HP finds itself embroiled in an extraordinary scandal after spying on journalists and its own directors to discover who was leaking boardroom secrets. At the same time, the options backdating furore, a hangover from the carefree days of the dot com boom that's hit Valley firms particularly hard, continues apace, with up to 80 companies now sucked in. Just this week, the former chief executive of Comverse Technology, who'd been sought around the world by the FBI in connection with allegations of options wrongdoing, was collared in Namibia.

While scandals make the headlines, however, there's a less dramatic issue bubbling that's ultimately far more significant for entrepreneurs - the state of the US capital markets. Despite the recovery of the tech sector, the opportunities for companies looking to go public in the US still look pretty poor. The volume of initial public offerings (IPOs) has dropped by 69 per cent from the years immediately preceding the bubble. By contrast, many non-US IPO markets are growing - and AIM, the London Stock Exchange's market for smaller companies, is doing better than most.

This contrast was borne out in a web seminar hosted last week by the US National Venture Capital Association and IBF Conferences. Stephen O'Leary, senior managing director at investment bank Jefferies Broadview, pointed out that the number of venture-backed IPOs averaged 52 per year from 2001-2006 in the US, compared to 178 before the bubble. Of those, just 20 are technology companies, compared to 89 before the dot com bust.

This slowdown contrasts with a rapid growth in mergers and acquisitions (M&As), which has quickly become the preferred exit path. Over the last six years, O'Leary said, there's been an average of 430 venture-backed M&A exits each year, compared to just 180 before the bubble. The only slight downside is that the activity is increasingly being concentrated in the hands of a smaller number of companies, with the likes of Cisco, VeriSign and Oracle repeatedly flashing the cheque book.

In the UK, by contrast, the markets are alive and kicking. Speaking from Jefferies Broadview's London office, managing director Charles Cameron said AIM has seen significant growth in the volume of IPOs over the last two years, with the average market capitalisation - the value of a company measured through its share price - reaching ₤63.8m so far this year. And increasingly, AIM is attracting the attention of smaller US companies. Almost 50 American companies are now on the market, most of them using it as their primary listing, and over 30 of those joined since January 2005.

So what is it that's keeping the volume of US IPOs suppressed and encouraging American companies to look abroad? As well as the fallout from the dot com bust and several technical factors affecting the way the markets operate, the harsher US regulatory environment in the form of Sarbanes-Oxley legislation is clearly an issue. In a week that saw Bernie Ebbers, former boss of Worldcom, and ex-Enron finance head Andrew Fastow begin 25-year and six-year jail sentences respectively, it's clear that the backlash against corporate corruption isn't about to ease off any time soon. By contrast, AIM takes a much more pragmatic, small company-friendly approach to regulation.

Whatever the causes, London tech firms have reason to celebrate. The more active a market is, the more options VCs have for an exit, so a healthy IPO scene should be good for investment. And for entrepreneurs thinking about their own long-term exit options, there's something of a comfort factor in AIM's growth. It can't be bad to know that US firms are prepared to travel thousands of miles to list on a specialist market based right on your own doorstep.

By Keith Rodgers, Webster Buchanan Research