PE Week Wire (Daily News Wire)

A year has passed since my PE Week Wire missive that drew comparisons between the 2004 World Series Champion Boston Red Sox and the repercussions on the venture capital market after passage of Sarbanes-Oxley (SOX). And you’ll find that some things haven’t changed. Today, the Red Sox continue to be a dominant force in baseball as they battle for first place in the AL East. And Congress remains unaffected by those speaking out against SOX compliance rules, which are still in place with no current hope for reform in sight. Case in point: the SEC recently announced that it intends to issue more guidance on SOX compliance, basically ignoring the NVCA and the 32 recommendations of the Committee for Small Public Companies which had spent the last year analyzing the challenges involved with Section 404 compliance and pleading for changes to its guidelines. Who now can we call a “bunch of idiots?”

In today’s ramblings, I will again stress the negative effect of SOX, but also illustrate some actions that we — as investors and companies — can take while Congress continues to “blow smoke” in our faces about reforming 404.

Yes, there is a band-aid that venture-backed companies can place over SOX to stop the lack of liquidity options for them in the U.S. In 2005, 901 companies received venture funding, while only 397 companies celebrated the fruits of liquidity in the form of 356 M&A transactions and 41 IPOs (according to MoneyTree). With the Nasdaq looking less and less open to venture-backed companies, investors can make congressional leaders sit up by exploring liquidity options outside of our borders, such as the London AIM Exchange, the Toronto Stock Exchange or the Japanese markets. If we threaten to take our money and our companies away from our native soil, then will Washington react? Well, maybe only if we include Halliburton as a strategic investor…

Over the past five years, Nasdaq has experienced limited growth in total market capitalization and an evident decline in the number of listed companies. True, the NASDAQ market is still significantly larger than AIM in terms of market cap, but we have to take into account the effect that 404 compliance rules have had on the IPO market. Today, our venture-backed companies need to possess yearly revenues between $80 and $100 million to even consider the Nasdaq IPO path. So where then can venture-backed companies turn?

I have my own skepticism of the benefits of moving overseas. As a cigar aficionado, I have a tendency to steer away from cities like London and Toronto that have declared themselves “smoke-free.” However, taking a hard look at the numbers has swayed me into exploring AIM as an option for some of the companies in our current GrandBanks portfolio. Compared with the Nasdaq market in 2005, London ’s AIM exchange showed a higher volume of new offering activity with 519 IPOs (45 on the Nasdaq), and raising a total of $11.5 billion vs. over $2 billion from companies on the Nasdaq. Looking at cost comparisons, the estimated expense to execute an IPO on AIM is approximately 30% less expensive than filing on the NASDAQ according to Canaccord Adams estimates. To maintain a listing on the AIM public market is 60% less than the Nasdaq according to the same study.

AIM becomes an even more attractive venueto venture-backed companies by offering a streamlined listing process and company-friendly requirements. SOX continued compliance costs, along with the added Nasdaq listing costs, require an EBITDA hit of nearly $2-3 million. Can we really, as a country, continue to focus our efforts on forcing our companies to continue to invest in these non-GNP operating expenses?

According to Ben Howe of America ’s Growth Capital, there has not been a single security company IPO in the last three years. SOX has effectively killed the classic U.S. technology IPO. Without a viable U.S. IPO market, our emerging growth technology companies are severely disadvantaged particularly against the growing competition from India and China . Top acquirers like Cisco, Microsoft, EMC and Symantec all smell the decline of the public market even through my heavy cigar smoke, and do not offer the IPO valuation premiums that we usually seek when pursuing M&A. This results in our portfolio companies suffering from a decline in exit valuations. These acquirers need to recognize that we do indeed have public market options and London ’s AIM is among those paths that we are pursuing.

There may not be a solution in sight on Capitol Hill, but we can still take action in the fight against SOX. With a former venture capitalist and prospective Presidential candidate as governor of Massachusetts , all we need now do is replace our current SEC head, Christopher Cox, with another Cox. I hereby nominate Greylock’s Howard Cox, a former NVCA Chairman who understands his way around both capital formation and D.C. (he worked earlier in his career for the Secretary of Defense).

So for those of you who want to make changes for our venture-backed companies, “pull out a Montecristo at a dinner party and the political liberal turns into the nicotine facist.”
— Martyn Harris, British journalist, Daily Telegraph 1/20/89