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?

Why Entrepreneurs Can Thrive During a Recession

Vivek Wadhwa, currently a Wertheim Fellow at the Harvard Law School and a successful tech entrepreneur, wrote a constructive article in Business Week, "Startups: The Upside of a Downturn", providing advice and encouraging entrepreneurs not to wait to start a business during a recession-- on the contrary, he identifies a recessionary environment as supportive of well-crafted new business opportunities.  For a link to the full article, click here.  

I've excerpted some of the core concepts in the article below:

"My advice for other tech entrepreneurs thinking of launching right now? Don't wait. A recession is your ally in building a lean, thriving company. Consider the following four advantages.

Less competition. An economic downturn clears the competitive landscape for startups. Most of the "me-too" companies with inferior products and weak business models go out of business, and fewer are started. Plus, it becomes a lot easier to do licensing deals with universities and business partners—no one else is.

Lower costs. It is a buyer's market, and you can negotiate deals on real estate, equipment, and materials like never before. Salaries are lower for new hires, and there is little pressure to give big salary increases to existing staff.

Easier to recruit and keep employees. You will readily find people who have been laid off and are eager to get back to work. They will accept lower salaries in return for stock and take the risk of joining a startup. And rather than focusing on getting a job with a competitor who pays a little more money, employees are usually content to build tenure and focus on your success.

Less pressure to expand. Rather than rushing to expand your business, you have the luxury of doing it right. You can conceive of better products, test them carefully to make sure they work and meet customer needs, and experiment with different business models. Since you are not in a frantic rush to get a product out or build market share, you can do things more methodically."

Building Alliances Between Venture Capitalists and Corporations- A Consistent Imperative

Building alliances between venture capitalists and corporations has never been more important than in today's extraordinarily volatile capital markets. We may be looking at a Brave New World in finance when markets re-equilibrate (and eventually they will), but knowing how to partner with large corporations-- who are both strategic business development partners as well as potential strategic acquirers of emerging companies-- will remain a constant for venture capitalists.

The National Venture Capital Association (NVCA) kicks off a new corporate webcast series on Friday, October 17, 2008 with a special complimentary webcast featuring Claudia Fan Munce, Managing Director, IBM Venture Capital Group, and Dan'l Lewin, Corporate Vice President, Microsoft Corporation, who have generously sponsored Partnerships for Prosperity: Building Alliances Between Venture Capitalists and Corporations.

I will be moderating the webcast, and we will discuss some of the challenges and best practices that venture capitalists should follow in order to optimize their relationships with IBM and Microsoft. The models that IBM and Microsoft follow are by no means identical, as they are influenced by different corporate cultures and business priorities. Claudia and Dan'l will share helpful tips on how to best work with their organizations as well as more general insights on successful corporate partnering strategies for VCs.

The new webcast series will follow this special launch event with other relevant content featuring global corporate leaders whose organizations seek to partner with venture-backed companies.

This webcast is complimentary to all NVCA members-- to register CLICK HERE TO LINK TO THE NVCA WEBSITE

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

"Fat, Dumb, and Happy"-- Intel CEO Craig Barrett Comments on American Competitiveness at Risk at Aspen Ideas Festival

KPCB's John Doerr interviewed Intel's Craig Barrett at the Aspen Ideas Festival on the impact of technology on our society and dives into the topic of the sustainability of American competitiveness in innovation. This topic is front and center for the American venture capital industry, as the National Venture Capital Association (NVCA) declared yesterday that a U.S. capital markets crisis exists for the start-up community. Just as the capital markets problems for emerging US companies are structural and have been building for years, Barrett accurately points to underlying structural issues in the U.S. educational system that put America at risk of losing its ascendance in innovation leadership.

Some ominous signs-- Intel used to make 90% of its investments in the US-- today the split is 50% US, 50% Asia. While the U.S. still has the best engineering schools in the world, Barrett points out that 60% of PhD graduates from US universities are foreign nationals. He notes that, due to our current visa policy, the US is stupidly sending them home after the US taxpayer has subsidized their education in this country. Watch the video:

Don't Forget What Makes America Great-- Our Diversity

As we celebrate this Memorial Day weekend and remember those who have died for our country in military service, let's not forget that our young men and women continue to fight to preserve our democratic society and the personal freedoms that define our way of life.

In his new book, The Post-American World, Council on Foreign Relations member Fareed Zakaria reflects on many of the challenges that we face as a country in the 21st century. He also reflects on the strengths that make America unique.

When I describe what makes the Silicon Valley eco-system for entrepreneurs unique and, in my view, exceedingly difficult to duplicate, my description mirrors what Zakaria describes as America's core strength:

" Per capita, it turns out, the United States trains more engineers than either of the Asian giants. ... America's hidden secret is that most of these engineers are immigrants. Foreign students and immigrants account for almost 50 percent of all science researchers in the country. . . . Half of all Silicon Valley start-ups have one founder who is an immigrant or first generation American. The potential for a new burst of American productivity depends not on our education system or R&D spending, but on our immigration policies. If these people are allowed and encouraged to stay, then innovation will happen here. If they leave, they'll take it with them. More broadly, this is America's great-- and potentially insurmountable-- strength. It remains the most open, flexible society in the world, able to absorb other people, cultures, ideas, goods, and services. The country thrives on the hunger and energy of poor immigrants."

I am a first generation American who, by the good fortune of being born and raised and Puerto Rico, was an American citizen before my immigrant parents were naturalized. But for the ultimate sacrifices made by American soldiers against the Nazis in World War II, I would not be here.

This Memorial Day, let's also not forget that the lifeblood of innovation and entrepreneurship comes from many places, but it has found a uniquely fertile soil in an America that embraces and celebrates diversity.

Sarah Lacy, Silicon Valley Host of Yahoo! Finance Tech|Ticker, Interviews Pascal, Sharon Wienbar (Scale Venture Partners), and Jessica Canning (Dow Jones/VentureSource) on Current VC Industry Trends

Last Thursday I joined Sharon Wienbar, Managing Director of Scale Venture Partners, and Jessica Canning, Director of Global Research for Dow Jones/ VentureSource, on Yahoo! Finance's Tech|Ticker program, hosted by Business Week's Sarah Lacy. We discussed issues ranging from opportunities in Clean Tech investing and the current state of tech IPO's to the implications of recent VC industry funding statistics and how entrepreneurs should manage their companies through an economic downturn. Two of the segments were posted this morning and can be accessed at http://finance.yahoo.com/tech-ticker

Marc Benioff and Warren Hellman Advocate Corporate Philanthropy at Jewish Community Federation Business Leadership Council Event

On February 7th, 300 people attended the third annual gala breakfast hosted by the San Francisco Jewish Community Federation's Business Leadership Council (BLC) to hear Warren Hellman, chairman and co-founder of Hellman and Friedman, and Marc Benioff, chairman and CEO of Salesforce.com, speak about the power of business leaders to produce positive social change. 

    The speakers moderated their own discussion, which focused on the positive role that the proactive advocacy of corporate philanthropy can play throughout an organization.  In response to a question from the audience as to whether promoting corporate philanthropy is inconsistent with creating sharholder value, Benioff forcefully replied that "doing good" absolutely builds shareholder value.  I strongly agree.

Warren Hellman, who serves on the board of Salesforce.com's charitable foundation, asked Marc to talk about the 1:1:1 model which he established at the early inception of Salesforce.com.  1:1:1 represents a pledge of 1% of the company's equity (when it was still private); 1% of profits (once you have them); and 1% of employees' paid time (6 business days per year) to charitable purposes.  Today, the Salesforce.com foundation employs 16 full-time staff and manages "tens of millions" of dollars.

The Business Leadership Council (BLC), which I currently chair, reaches out to over 1,500 Jewish professionals in the Bay Area through close to a dozen events each year.  We host smaller seminars (30 to 80 people) on topics ranging from current trends in real estate to protecting intellectual property; and larger networking events (200+ people) designed to bring people together to meet in a community that shares both business and philanthropic goals.  We have barely scratched the surface in reaching out to the 6th largest Jewish community in America.  If you want to learn more about the BLC, go to www.sfjcf.org and click on the Business Leadership Council.   

 

Missing the Point-- WSJ Reports on Splitting the Chairman and CEO Roles in Public Companies

The Wall Street Journal's January 14th article "When Chairman and CEO Roles Get A Divorce" explores the increasing trend toward separating the Chairman and CEO titles.  Unfortunately, it fails to raise a critically important question-- is it advisable for former CEO's to remain on their own boards as independent directors, much less as chairmen? 

The article points out that "36% of Standard & Poor's-500 companies have separate chairmen and CEO's, up from 22% in 2002, according to the Corporate Library, a research group in Portland, Maine."  The article does not note that the S&P 500 lags significantly behind all public corporations in this regard, as 49% of all U.S. public companies have inside chairmen vs. 51% that do not, according to the Corporate Board Member / PricewaterhouseCoopers Survey, What Directors Think 2007.

The Journal writes in the context of James Cayne's resignation as the CEO of Bear Stearns last week, noting that Cayne remains board chairman.  Reporting from London, the WSJ reporter, Joann S. Lublin, observes the following:

"As at Bear Stearns, splits in the top posts at American businesses are often the result of a leadership transition or financial trouble.  In numerous cases, the chairman is a concern's retired CEO.  Yet the gradual emergence of non-CEO chairmen in the U.S. raises a sticky question: How do you perform a role that rarely existed until recently?"

While the article goes on to discuss the dynamics of groups that have been formed to provide peer support for independent board chairmen, I would like to pose a different, and perhaps more difficult, question.

Why doesn't Jimmy Cayne make a clean break from Bear Stearns and become the chairman of another board?

Keeping former CEO's on the board of your company is generally contra-indicated for several obvious reasons:

*First, most former CEO's have strongly held continuing views and core beliefs as to how the company should continue to be run;

*Second, it is emotionally very difficult for former CEO's to let go of such strongly held convictions; and

*Third, people have a natural tendency to second-guess other people.

These emotionally charged issues are only compounded when a CEO moves to the chairman's role under a cloud of some sort, as Ms. Lublin observes above. 

I wrote an extensive article on this topic in the Spring 1999 issue of Directors & Boards magazine, "The Problem of Emotion in the Board Room", in the context of the challenges faced by public and private companies.  A strong case can be made that former CEO's should normally not remain on the board of their former company, as chairman or otherwise.  They can be great directors and great chairmen, but they should accept these roles at new companies where they can perform in leadership positions without the emotional baggage they carry in the transition from the incumbent CEO role. 

I concluded the Directors & Boards article with the following:

"Walter Wriston, who retired as CEO and as a director of Citicorp in 1984, observed in a 1993 article in Directors & Boards that 'In short, there are a myriad of reasons for the retiring CEO to leave the board, and few if any arguments for the other course... the human desire to stay on with a company that has been home for many years is stong and understandable, but the world is so full of so many other interesting things to do that the desire to stay should be resisted doe one's own sake and for that of the company.' "