pascalsview

A Case Study in the Unintended Consequences of Financial Market Regulation: The Death of the Small Cap U.S. IPO?

The first 100 days of the Obama administration are widely expected to usher in a new era of U.S. capital markets regulation designed to restore the public’s trust in the decimated institutions that provide much of the liquidity infrastructure for the global capitalist system.  It is imperative that improved financial oversight be achieved swiftly through the enactment of effective regulation so that the markets can re-equilibrate and resume their normal function.  Without these necessary changes, global economic growth will continue to falter.

At the same time, we must recognize that regulations enacted in haste can have severe, negative unintended consequences.  The current moribund state of the American IPO market is a real-time case study in such unintended regulatory consequences.  Of equal import is the fact that the IPO drought is structural, not cyclical, and this has far reaching implications for the future of innovation in America. 

On November 19^th, Grant Thornton released a white paper, “Why Are IPO’s in the ICU?” written by David Weild, former Vice Chairman of the NASDAQ, and Edward Kim, former head of NASDAQ product development, both now principals at Capital Markets Advisory Partners. 

To download the white paper click Download Why are IPOs in the ICU_11_19 :  

The paper was presented to the NYSE and National Venture Capital Association’s Blue Ribbon Regional Task Force, which has been convened to make specific recommendations to the Obama administration in January regarding changes that must occur if America is to restore the small cap IPO as a compelling and differentiated positive feature of our capital markets.

The paper is concise and makes a cogent case as to how we got here.  If you want to understand why the IPO market has died and why the middle market for public emerging growth companies has effectively ceased functioning, you must read this paper.

 I agree with the paper’s overall thesis and with a number of its important assertions, including:   

* While conventional wisdom may say the U.S. IPO market is going through a cyclical downturn, exacerbated by the recent credit crisis, many are beginning to share a view of a new and much darker reality: The market for underwritten IPOs, given its current structure, is closed to most (80 percent) of the companies that need it. 

* The lack of an IPO market has caused venture capitalists to avoid financing some of the more far-reaching and risky ideas that have no obvious Fortune 500 buyer. Gone are the days when most venture capitalists would so willingly pioneer new industries and technologies (e.g., semiconductors, computers and biotechnology) that have no obvious outlet other than the IPO market.

* Regulators may have unwittingly done a real disservice to mom and pop investors by enabling traders to hijack the markets for speculation. This phenomenon can be seen by the large Wall Street firms who have witnessed their top 10 (by revenue) institutional investors — which only a decade ago were “long- only” mutual funds such as Fidelity and Alliance — be displaced by hyper-trading long-short hedge funds.

* The U.S. will lose its competitive advantage in developing, incubating and applying new technologies. Technologists are already returning to foreign jurisdictions like China and India where government has devised an increasing array of economic and capital markets incentives to compete.

The lack of IPO’s in the U.S. has broad, negative implications for continued risk taking by U.S. venture capitalists. If we have no public market liquidity for emerging growth companies, there will be no next generation of American technology giants. The demise of the technology IPO has also contributed to the structural breakdown in the broader cycle of research and development that underlies the American innovation crisis heralded by Silicon Valley thought leaders such as Judy Estrin.

 

If you have constructive recommendations for reforms that you believe should be enacted to support a renewed IPO market, please contact me at pascal@levp.com, and I will forward your suggestions to the NVCA.

"Bailing Out Wall Street" Commonwealth Club Panel Broadcast on KALW 91.7 November 11 at 7PM PST

KALW 91.7 FM, the local San Francisco National Public Radio station, will be broadcasting "Bailing Out Wall Street", the lively election-eveCommonwealth Club INFORUM panel on which I participated, tomorrow at 7 PM PDT.   In front of a live audience of over 200 people, we shared differing views on the wisdom of the Federal Government's emergency relief and assistance program to the banking and finance industries-- commonly tarred as the "Wall Street Bailout".  Our vigorous discussion was fueled by the nature of the panelists, as I joined Dave Callaway, Editor-in-Chief, MarketWatch, Jonathan Berk, Professor, Graduate School of Business, Stanford University, and Maggie Mui, San Francisco Market Regional President, Wells Fargo.  The panel was expertly moderated by Kathleen Pender, Net Worth Columnist, San Francisco Chronicle.

 

Dave Callaway, Maggie Mui, Jonathan Berk, Pascal Levensohn, and Kathleen Pender

Some of the thorny questions we addressed: 

• Will the bailout work and is it really a bailout?
• Did the Treasury's decision to throw Lehman Brothers under the proverbial bus on September 13 light the match for the panic that subsequently routed financial markets?
• What are the current prospects for entrepreneurs and for continuing innovation in Silicon Valley during these recessionary times?
• Are we going to drown in new securities regulations with unintended negative consequences?

A New Dawn for America

I feel particularly optimistic tonight, and I see sunlight in America's future. Gathering with my family in front of the TV, and listening to Senator McCain's gracious concession speech, my greatest hope is that a sense of bipartisanship, motivated by the desire to act in the best long term interests of America, will drive our country forward to a truly better place through the difficult times that remain ahead.  It is easy to be cynical about politics and elections, but the demographic facts about this election stand cynicism on its head.  As Barack Obama said tonight, in America, anything is possible.  As we go forward, let's not forget this.  We can rise above our own selfish interests to do the right things for our country. Tonight, I am more proud to be an American than ever before, and I feel very fortunate to be a first generation American who not only has lived the American dream, but who continues to believe in the American dream for my children and for all Americans.

"In this country we rise or fall as one nation, as one people."

President-Elect Barack Obama

November 4, 2008

 

Why I am Voting for Barack Obama for President of the United States

I have been a registered Independent voter since 1994.  Like many Americans, I've given more thought to this election than to any previous political contest. Many of us share a deep sense of unease as we witness a degree of instability and see a snowballing lack of confidence in  our country's economic and political institutions that was considered impossible in America. I feel strongly that my vote in 2008 may well be the most important exercise of this civic duty in my life. 

In supporting Barack Obama, like General Colin Powell, I also believe that Senator Obama is a "transformational figure".  I trust Barack Obama's judgment and believe in his ability to successfully lead this country through the dark period that engulfs our national psyche.  I also believe he is sincere in his desire to "do the right thing" for America.  His specific position on eliminating capital gains taxes for start-ups supports long-term investing through innovation and venture capital.  This approach recognizes that there are no quick fixes to our economic problems and that America needs to resume a path toward sustainable long-term economic growth through new job creation.  

In my view, the Washington Post's endorsement of Barack Obama for President on October 17 most closely reflects my own personal opinions.  Below, I have quoted some excerpts from the Post's editorial which capture the essence of my strong support for Barack Obama:

"Mr. Obama is a man of supple intelligence, with a nuanced grasp of complex issues and evident skill at conciliation and consensus-building. At home, we believe, he would respond to the economic crisis with a healthy respect for markets tempered by justified dismay over rising inequality and an understanding of the need for focused regulation. Abroad, the best evidence suggests that he would seek to maintain U.S. leadership and engagement, continue the fight against terrorists, and wage vigorous diplomacy on behalf of U.S. values and interests. Mr. Obama has the potential to become a great president. . . .

A McCain presidency would not equal four more years [of the Bush administration], but outside of his inner circle, Mr. McCain would draw on many of the same policymakers who have brought us to our current state. We believe they have richly earned, and might even benefit from, some years in the political wilderness. . . .

There are two sets of issues that matter most in judging these candidacies. The first has to do with restoring and promoting prosperity and sharing its fruits more evenly in a globalizing era that has suppressed wages and heightened inequality. Here the choice is not a close call. Mr. McCain has little interest in economics and no apparent feel for the topic. His principal proposal, doubling down on the Bush tax cuts, would exacerbate the fiscal wreckage and the inequality simultaneously. Mr. Obama's economic plan contains its share of unaffordable promises, but it pushes more in the direction of fairness and fiscal health. Both men have pledged to tackle climate change. . . .

Mr. Obama also understands that the most important single counter to inequality, and the best way to maintain American competitiveness, is improved education, another subject of only modest interest to Mr. McCain. . . .

A better health-care system also is crucial to bolstering U.S. competitiveness and relieving worker insecurity. Mr. McCain is right to advocate an end to the tax favoritism showed to employer plans. This system works against lower-income people, and Mr. Obama has disparaged the McCain proposal in deceptive ways. But Mr. McCain's health plan doesn't do enough to protect those who cannot afford health insurance. Mr. Obama hopes to steer the country toward universal coverage by charting a course between government mandates and individual choice, though we question whether his plan is affordable or does enough to contain costs. . . .

It is almost impossible to predict what policies will be called for by January, but certainly the country will want in its president a combination of nimbleness and steadfastness -- precisely the qualities Mr. Obama has displayed during the past few weeks. When he might have been scoring political points against the incumbent, he instead responsibly urged fellow Democrats in Congress to back Mr. Bush's financial rescue plan. He has surrounded himself with top-notch, experienced, centrist economic advisers -- perhaps the best warranty that, unlike some past presidents of modest experience, Mr. Obama will not ride into town determined to reinvent every policy wheel. Some have disparaged Mr. Obama as too cool, but his unflappability over the past few weeks -- indeed, over two years of campaigning -- strikes us as exactly what Americans might want in their president at a time of great uncertainty. . . .

...Mr. Obama, as anyone who reads his books can tell, also has a sophisticated understanding of the world and America's place in it. . . .We hope he would navigate between the amoral realism of some in his party and the counterproductive cocksureness of the current administration, especially in its first term. On most policies, such as the need to go after al-Qaeda, check Iran's nuclear ambitions and fight HIV/AIDS abroad, he differs little from Mr. Bush or Mr. McCain. But he promises defter diplomacy and greater commitment to allies. His team overstates the likelihood that either of those can produce dramatically better results, but both are certainly worth trying. . . .

Thanks to the surge that Mr. Obama opposed, it may be feasible to withdraw many troops during his first two years in office. But if it isn't -- and U.S. generals have warned that the hard-won gains of the past 18 months could be lost by a precipitous withdrawal -- we can only hope and assume that Mr. Obama would recognize the strategic importance of success in Iraq and adjust his plans. . . .

We also can only hope that the alarming anti-trade rhetoric we have heard from Mr. Obama during the campaign would give way to the understanding of the benefits of trade reflected in his writings. A silver lining of the financial crisis may be the flexibility it gives Mr. Obama to override some of the interest groups and members of Congress in his own party who oppose open trade, as well as to pursue the entitlement reform that he surely understands is needed. . . .

… the stress of a campaign can reveal some essential truths, and the picture of Mr. McCain that emerged this year is far from reassuring. To pass his party's tax-cut litmus test, he jettisoned his commitment to balanced budgets. He hasn't come up with a coherent agenda, and at times he has seemed rash and impulsive. And we find no way to square his professed passion for America's national security with his choice of a running mate who, no matter what her other strengths, is not prepared to be commander in chief. . . .

… Mr. Obama's temperament is unlike anything we've seen on the national stage in many years. He is deliberate but not indecisive; eloquent but a master of substance and detail; preternaturally confident but eager to hear opposing points of view. He has inspired millions of voters of diverse ages and races, no small thing in our often divided and cynical country. We think he is the right man for a perilous moment."

It's Time for America to Get Back Into the Storage Business

I used to be in the moving business. Eighteen years ago, after working for seven years in the risk arbitrage business, one of the many 'moving' businesses of Wall Street, I left New York to come to San Francisco in order to get into the 'storage' business. America's strong economic foundations are rooted in multi-year business building and long-term risk taking. We are now bearing witness to the sour fruits of moving securities around like meaningless scraps of paper for short-term profit and the securitization of risk into a daisy chain of the unknown and the unmanageable.

Over the past 20 years, the average holding period for stocks has declined from 2+years to just 3 months as of earlier this year. A root cause of the relentless volatility in the equity, commodity, and debt indexes is the steady erosion of long term thinking in investing, not only in this country, but all over the world. How many public company CEOs have lamented the wholly inconsistent demands of managing quarterly earnings expectations for fickle institutional investors while maintaining a consistent long term operating strategy to maximize shareholder value?

It's time for a global re-boot of the investor mindset so that people can start investing responsibly-- there are many reasons why Warren Buffett is such a successful investor, and long-term thinking is one of them.

I can thank Brett Haire, my boss at First Boston during the 1980's, for inspiring me to leave Wall Street and risk arbitrage behind. I remember once asking Brett for permission to accumulate a long-term, unhedged position in the spin-out of a company that we were researching for investment. Brett looked at me, incredulous, and said, "Pascal, we're in the moving business here, not in the storage business." At that moment I realized that I did not want to be in the moving business and initiated the career path that led me to become a venture capitalist.

America needs to get back in the storage business at many levels and actively promote the entrepreneurial spirit that built this country one brick at a time at the same time that we re-build our securities markets. Let's learn from our mistakes.

What Would Teddy Roosevelt Say Now?

"The things that will destroy America are prosperity at any price, peace at any price, safety first instead of duty first, and love of soft living and the get-rich-quick way of life."

Theodore Roosevelt, 1917

Would he say, "I told you so...?"

The SEC's Colossal Failure of Oversight-- Isn't This a Violation of the Business Judgment Rule?

The damning New York Times headline, "SEC CONCEDES OVERSIGHT FLAWS FUELED COLLAPSE," from a September 26th article by Stephen Labaton, will hopefully end up as more than a footnote in the long list of misdeeds by the 'stewards' of the American economy that have brought American capitalism to the precipice of systemic financial collapse. According to the article, a report by the inspector general of the SEC asserts that "voluntary regulation does not work" and that the SEC's oversight program for the investment banks "was fundamentally flawed from the beginning."

The article goes on to state:

The report found that the S.E.C. division that oversees trading and markets had failed to update the rules of the program and was “not fulfilling its obligations.” It said that nearly one-third of the firms under supervision had failed to file the required documents. And it found that the division had not adequately reviewed many of the filings made by other firms. The division’s “failure to carry out the purpose and goals of the broker-dealer risk assessment program hinders the commission’s ability to foresee or respond to weaknesses in the financial markets,” the report said.

We should not gloss over the importance and the far reaching nature of this indictment of the SEC by the SEC's inspector general. The most fundamental fiduciary duty in business is the Duty of Oversight. Oversight is a theme which binds together the more commonly referred to fiduciary Duties of Care, Loyalty, Confidentiality, and Disclosure. Violators of the fiduciary duties listed above often seek refuge in the Business Judgment Rule and try to to hide behind 'squishy' judgment call concepts like "good faith" and "honest belief". But the Business Judgment Rule stands on oversight, and the SEC clearly failed in its duty of oversight of the investment banks. In my view, in addition to the bankers, the regulators themselves should also be held responsible for this crime against America.

Below is a definition of the rule, taken from the white paper, "A Simple Guide to the Basic Responsibilities of VC-Backed Company Directors", written by the Working Group on Director Accountability and Board Effectiveness:

Business Judgment Rule
Creates a presumption that in making a business decision, the directors of a company acted on an informed
basis, in good faith and in the honest belief that the action taken was in the best interests of the company.
The business judgment rule helps protect a director from personal liability for allegedly bad business
decisions by essentially shifting the burden of proof to a plaintiff alleging that the director did not satisfy
its fiduciary duties. This presumption and the protections afforded by the business judgment rule are lost if the directors involved in the decision are not disinterested, do not make appropriate inquiry prior to
making their decisions, or fail to establish adequate oversight mechanisims.

All corporate directors and persons in positions of accountable oversight responsibility need to commit these rules to memory-- and, more importantly, to act on them in the daily course of business.

Best Practices for VC Directors Involved in M&A Transactions in Today’s Challenging Environment

Dave Barry, Managing Editor of Dow Jones Financial Information Services, has invited me to join a panel of M&A experts on September 26 to discuss best practices and some of the key challenges currently facing VC-backed company boards involved in mergers and acquisitions. Joining me on the panel are Jeff Laborde, Vice President in Goldman Sachs’ Technology Investment Banking Group, who represented our portfolio company Rapt earlier this year in Rapt’s acquisition by Microsoft. John Peters, former CEO of our portfolio company Reconnex, which McAfee acquired recently, will also be a panelist. Ron Star of Howard Rice joins us to bring the legal perspective to this webinar.

Any venture capitalist involved in or considering an M&A transaction knows that the dynamics of acquisitions in today’s market have shifted such that there is an asymmetric negotiating advantage favoring large corporations (greater resources, always able to ‘wait until next quarter’). Levensohn Venture Partners completed three acquisitions of our portfolio companies so far this year, so I have a very current perspective on the challenges and opportunities of the technology M&A market.

This webinar should be both lively and enlightening as my fellow panelists bring deep experience and best practices knowledge to the discussion. Today, and until we see a robust IPO market re-emerge for growth companies with market capitalizations below $1 billion, M&A is the only way to generate liquidity for most venture portfolios. We will discuss the challenges associated with getting deals done and recommend best practices to optimize outcomes for emerging companies.

To register online for Best Practices for Board Members Priming VC-Backed Companies For M&A
on September 26, 2008 go to http://events.dowjones.com/webinars/20080926.html

Beijing Olympics Journal: I Have Michael Phelps' T-Shirt

When Michael Phelps won the Olympic Gold medal for the Men's 200m Butterfly earlier this week, I was excited to be there as a witness to part of his record breaking eight Gold medal run in Beijing. Little did I know that I would bring an historic piece of Michael Phelps' wardrobe back to San Francisco with me.

I was sitting in the second row at the left of the pool, near the medal ceremony podiums, and Phelps was carrying a red shirt balled up in a knot after he received his medal and began the ceremonial walk in front of the crowd to show off the medals.

At his first stop, he paused to throw the shirt into the crowd-- directly into my right hand for a one-handed catch. "Team Levensohn" pictured below with my new shirt-- I will not wear it again-- it is going into the Levensohn Olympic Memorabilia Gallery. This was certainly the highlight of my Olympics!

Wind Power and Natural Gas-- Some Thoughts on the Pickens Energy Plan

Boone Pickens made his fortune on oil and has been a bull on natural gas since before I invested in the Mesa takeover attempt of Texaco in 1988. Now he is a bull on wind power and believes that the combination of wind farms and transitioning the nation's autos from oil to natural gas powered vehicles will deliver the knockout blow to the oil monopoly.

The United States is the "Saudi Arabia of wind", as Pickens describes our country on his website pickensplan.com. Pickens believes we should capitalize on our natural wind power and points to rippling positive economic benefits from the creation of new jobs at windpower generating stations in rural America, noting the population gains and tax revenue increases from wind power generating stations in Sweetwater, Texas as an example of this rural renewal.

According to an April 2008 article in The Guardian:

"Over the next four years he [Pickens] intends to erect 2,700 turbines across 200,000 acres of the Texan panhandle. The scheme is five times bigger than the world's current record-holding wind farm and when finished will supply 4,000 megawatts of electricity - enough to power about one million homes".

On an even larger scale, Pickens estimates the overall cost of transtiioning to wind power in the U.S. as follows:

"Building wind facilities in the corridor that stretches from the Texas panhandle to North Dakota could produce 20% of the electricity for the United States at a cost of $1 trillion. It would take another $200 billion to build the capacity to transmit that energy to cities and towns. That's a lot of money, but it's a one-time cost. And compared to the $700 billion we spend on foreign oil every year, it's a bargain."

I would appreciate any comments from those who are familiar with the economics of wind power in action-- particularly the successful experience of Germany with wind power.

While the Pickens Plan may make a lot of sense, the website, and what I have heard of the Pickens message so far, omit a major element required for success-- immediate moves by American energy consumers to reduce energy demand and increase energy conservation.

The highest impact action we can take to break the oil monopoly and to eliminate our oil addiction is to go cold turkey-- drug addicts break their dependency by changing their behavior. Notice how the market oil price drop from $147 to $128 in the last week reflects increasing signs of reduced demand for oil driven by global economic weakness combined with noticeable reductions in demand in the United States over the past twelve months.

We need to permanently change our consumption behavior and develop new patterns that will put a permanent brake on oil price increases during the period of transition. It will take decades to reach a new supply/demand equilibrium as we develop permanent substitutes for oil through renewable energy sources. Sustainable energy solutions will doubtless include wind power and solar power as well as other innovations.

But demand management will make a difference in oil consumption now and does not cost $1 trillion to implement. Change your behavior today to make a difference now!