Looking for an Exit: Startup Founders, Investors, and Bankers Offer Some IPO Guidance

Xconomy San Diego — 

There have been 108 IPO filings nationwide so far this year, which is more than seven times the paltry 15 filings that were made by this time last year, according to IPO data from Renaissance Capital. The big local story so far has been Carlsbad, CA-based MaxLinear (NYSE: MSL), a wireless chip design company founded by CEO Kishore Seendripu, which raised almost $90 million in its IPO in March. (About $50 million of that was intended for the company’s capital needs, and the rest largely for investors). San Diego’s Trius Therapeutics, which registered for a $78 million IPO in November, postponed its plans in March to conform its Phase 3 protocol for its antibiotic drug candidate, torezolid phosphate, to accomodate new guidance issued by the FDA.

So what are the factors affecting IPOs, and what kind of guidance are San Diego’s experienced CEOs and other experts offering about taking startups public? The San Diego Venture Group organized a discussion on the topic at its monthly meeting last week at the Hyatt Regency La Jolla. Here are some of the key points they provided:

—Startups and their boards are giving more serious consideration nowadays to reverse mergers with shell companies (usually public companies with inactive business), according to Byron Roth, chairman and CEO of Roth Capital Partners, a leading investment bank for small-cap public companies that’s based in Newport Beach, CA. “Reverse mergers used to be a penny stock promoter’s game,” Roth says. “But now it’s a hybrid between an IPO and a private buyout.” Reverse mergers can represent an attractive alternative for companies that are looking to raise relatively small amounts of capital—less than $50 million—by structuring the financing in a way that enables a hedge fund to make a private equity investment in the new public company immediately after the reverse merger takes effect. Roth says many hedge funds have rules that restrict them from making investments in private companies, but a variety of PIPE-type financings (Private Investments in Public Entity) can be structured to close almost simultaneously with the reverse merger.

—The advice to startup founders offered by James Sweeney, who started CardioNet (NASDAQ: BEAT) in San Diego and oversaw its 2008 IPO at a valuation of more than $425 million, is “to avoid going public at all costs.” Sweeney says the reason most companies go public is because they have “tired investors… The VC investors want out, and you have to look for a new type of investor, and ideally one who has a 15- to 20-year time horizon.”

—In contrast, MaxLinear’s Seendripu says he felt no pressure from his board to take MaxLinear public. Rather, he says it was a calculated decision driven mostly by MaxLinear’s senior executives and was based on their reasoning that corporate valuations had been beaten down by the recession, and would rise—much like Southern California’s residential real estate market.

—While the timing of MaxLinear’s IPO on March 24th proved impeccable, Roth says he advises startups against trying to time the market. “We used to say there were good years for IPOs and bad years,” Roth says. “Then we started looking a good quarters or bad quarters.” Now market volatility has reduced the opening of an IPO window to a few weeks, or even days.

—Volatility also is a bane to Sweeney, who now heads PatientSafe Solutions—his ninth health care company. Volatility is an inherent part of the markets, yet Sweeney says, “government intervention” since his first IPO in 1981″has done everything possible to destroy to process” of taking a company public. The level of predictability in financial reporting “is almost like being a Fortune 500 company,” Sweeney says, and Wall Street investors and analysts expect IPO candidates to show $100 million in annual revenue, no debt, and profitability. “The bottom line to going public is so huge that you can’t afford to go public.”

—Seendripu says he got similar advice before MaxLinear’s IPO, with most people counseling him to avoid going public. But he was encouraged to stay the course by Ted Alexander, a Mission Ventures managing partner and MaxLinear board member. “Ted was steadfast,” Seendripu says, “but I almost buckled and didn’t do the road show.”

In talking with startup founders, Seendripu says his advice is that “fundamentally, you should do it if you think you need to do it and if your plans call for it. But you have to believe in the goodness of people…I can’t tell you what it means to be a great company [yet],” Seendripu says, “but to be an entrepreneur, you have to be a bootstrapper. You have to be passionate in your belief that the market will reward those people who believe in themselves.”