Will 2014 bring sustained momentum for venture-backed IPOs?
Introduction
Initial public offerings continued their rapid rise in 2013, aided by the strong performance of the U.S. public equity markets. Last year, 222 companies successfully completed their IPOs. Those IPOs included 82 venture-backed companies, such as the blockbuster debut of Twitter in November, and comprised the highest number of venture-backed IPOs since 2007.
So will the momentum continue in 2014? We believe so. Is the pattern similar to the late 1990s, indicating an imminent bust? We believe not.
Because of our position as an investor in venture capital funds, we are often in a position to see the fundamentals of the underlying portfolio companies, whether those companies are public or private. What we are observing is that the fundamentals of the venture-backed pre-IPO companies are much stronger than in previous cycles. In addition, we believe there are many strong macro-economic factors present in today’s economy to help sustain the momentum of growth, despite the continuing uncertainty.
The pipeline of strong venture-backed pre-IPO companies is robust. These companies have significant revenues and growth, with investment bankers setting rational pricing for the IPOs as compared to the previous decade.
The macro-economic fundamentals remain strong with the U.S. economy’s GDP growing at a pace of 3.2%. Household net-worth reached a five-year high in 2013, and lower mortgage rates helped revive home sales that have only recently dipped.[ii] We believe these factors will allow venture-backed IPOs to continue their boom and help drive venture returns and liquidity in 2014.
The IPO Class of 2013 – Strong on Fundamentals
The IPO class of 2013 was strong on fundamentals, particularly in the magnitude of their revenues and year-over-year growth. Over 35% of the companies that completed an IPO in 2013 were backed by venture funds, generating $9.6 billion in proceeds. A total of 75% of the venture-backed IPO filings were driven by technology and healthcare sectors.[iii] As seen in Table 1, the number of 2013 venture-backed IPOs increased 71% and proceeds increased 120% compared to 2012. Note that this calculation excludes the record Facebook IPO that accounted for $16 billion in proceeds in 2012.
| Table 1: IPO Trends | 2012* | 2013 | Change |
| Total # of IPOs | 127 | 222 | 75% |
| Venture-backed IPOs | 48 | 82 | 71% |
| Venture-backed proceeds (bn) | $5 | $11 | 120% |
*2012 data excludes the record Facebook IPO, which represented $16 billion in proceeds.
Source: Jay Ritter, University of Florida and the NVCA
The 2013 venture-backed IPO companies show strong revenues and a potential for future growth. According to Thomson Reuters, the top 15 companies ranked by trailing twelve-month revenues showed average revenues upwards of $209 million. The entire pool of 82 venture-backed IPO company candidates averaged $65 million in revenues.[iv]
| Table 2: Top 15 Venture-Backed IPOs by Revenue (2013) | |||
| Sr. No | Company Name | Revenues ($M) | Time to Exit (Years) |
| 1 | Criteo SA | $617 | 7.5 |
| 2 | Zulily Inc | $331 | 3.9 |
| 3 | Twitter Inc | $317 | 6.3 |
| 4 | Potbelly Sandwich Works | $275 | 12.0 |
| 5 | Chegg Inc | $213 | 7.2 |
| 6 | Barracuda Networks Inc | $199 | 7.9 |
| 7 | Silver Spring Networks Inc | $197 | 9.3 |
| 8 | Gogo LLC | $169 | 16.9 |
| 9 | RingCentral Inc | $146 | 6.8 |
| 10 | RetailMeNot Inc | $145 | 3.2 |
| 11 | YuMe Inc | $117 | 5.8 |
| 12 | Control4 Inc | $110 | 10.0 |
| 13 | Rocket Fuel Inc | $107 | 5.2 |
| 14 | Tremor Video, Inc. | $105 | 6.8 |
| 15 | Cyan, Inc. | $96 | 6.2 |
| Average (Top 15) | $209 | 7.7 | |
| Average (All Venture-Backed IPOs) | $65 | 8.19 |
The average pre-IPO valuation in 2013 was $578 million and the increase in price from private-to-public was a multiple of 3.4x. In 2000, IPOs were priced at a “stratospheric” median of 30x sales, compared with the more modest 5.2x last year.[v] The average first day price change was 25.4% for all venture-backed companies going public in 2013. These trends indicate that a realistic pattern of pricing is more prevalent now than in the late 1990’s boom that was followed by a bust.
As an example of the strength of some of the 2013 IPOs, consider Zulily, which within a span of four years reported revenues of $331 million with a compounded annual growth rate of 325%. Or RocketFuel, which raised a Series C round at $160 million valuation[vi] and filed for IPO after 30 months at a $1 billion valuation. The first day “pop” was 93% above the opening price of $26.[vii] Security startup FireEye raised about $100 million of total venture financing and completed its IPO at a $2.3 billion valuation. The company experienced revenue growth of an 8x multiple from 2010 to 2012 and yielded a first day trading pop of 80%. Marketing and analytics companies, Marketo and Tableau Software showed similar first day pops of 60% to 75% indicating high demand. By the end of the year, the average venture-backed deal gained 52%; 16 venture-backed companies more than doubled their respective offer prices.[viii]
Table 2: Top 15 Venture-Backed IPOs by Revenue (2013)
| Average CAGR as of IPO | 168% |
| Highest CAGR | 466% |
| Number of companies above 100% CAGR | 22 |
| Highest first day pop | 104% |
| Average first day pop | 25% |
CAGR is defined as compound annual growth rate.
The IPO market in 2013 was the start of stronger fundamentals for companies and market dynamics. Those same fundamentals appear to continue in 2014.
2014 IPO Candidates: Strong on Growth
According to Renaissance Capital, the first quarter of 2014 has already seen more IPOs than the first quarter of 2013 (37 vs. 31). As of February 28, 2014, IPO proceeds are 27% higher than last year, despite a 31% dip in average deal size. The number of initial filings in January and February is the highest it has been in over a decade. At this measure, 2014 could outpace 2013.
CB Insights estimates at least 26 companies at over $1 billion valuation are primed to file for IPO in 2014. We are aware of many venture-backed private companies both in our portfolios and across many others that are approaching an IPO. Some companies may complete public offerings in 2014 include:
Other venture-backed technology companies including Cloudera, AppDynamics, SugarCRM, Airbnb, Eventbrite and Evernote are also slated to enter the public markets in 2014. A detailed table of filings is included in the appendix. What we have seen in the industry is several of these companies growing upwards of 30% year-over-year, and others like Box, Square, Zoopla, Supercell and Kabam are reaching even higher year-over-year growth. In fact, the average for tech companies in our venture funds’ underlying portfolios of companies pre-IPO for which we have data is $150 million revenues and 35% year-over-year growth—some we’ve seen demonstrate 100% year-over-year growth. These growth rates and robust revenues for pre-IPO venture-backed companies point to an increasing trend of stronger companies entering the public markets. This causes us to be optimistic about the potential for continued IPO momentum.
Opportunities and Challenges
The roster of 2014 IPO candidates is showing good promise to bring exciting investment opportunities to investors. With a potential growing interest rate environment, it is likely that investors will gradually rotate away from high yield products into growth and equity investments such as venture-backed companies. Additionally, there are many other positives to indicate continued venture IPO strength but there are also concerns around sustaining the trend.
Positives:
- Less capital required to start companies: The cost of starting companies has reduced by a factor of 99x since the early days of classic venture capital investing. This has launched a new wave of startups tackling cloud, mobility and security opportunities with much more capital efficiency – less capital at risk to reach major milestones.
- Large and diverse pool of pre-IPO companies: There is a diverse population of companies across sectors (Consumer, Enterprise, Hardware, and Biotech) which will maintain the potential for growth in revenues and thus returns in 2014.
- Companies are entering IPOs at a later cycle in their growth: Venture-backed companies are going public later in their life cycle. This reduces the risk of performance and such companies are more “market-ready” than what we may have seen in the previous boom cycles. Such companies have a better ability to meet or beat quarterly Wall Street expectations readily as compared to those who entered earlier in their lives. There is no substitute to tangible revenues and repeat customers – a characteristic of the current IPO market.
- Strong revenues and growth: Venture-backed IPO candidates are establishing significantly higher standards prior to exploring IPO filings. Revenues and the year-on-year growth rates far exceed other investment options available in the current market. More importantly, the expected total rates of return for such companies (on a risk-adjusted basis) can outperform most fixed income products in a rising interest rate environment. This dynamic should help keep the IPO window open, regardless of what happens geopolitically or to financial market performance.
- Innovation has not stopped: Venture-backed companies driven by innovation in cloud, mobility, biotech, and hardware continue to grow as they address significant market needs with innovative solutions and technology, generating meaningful revenues, which can result in superior returns.
Concerns:
Quality versus speed: For investment bankers, the ability to underwrite offerings is often a function of company performance combined with market sentiment. Yet in such times, opportunistic behavior sets in where bankers want to “get one more done”. Such a stampede could hurt the qualitative filters, allowing lesser-quality IPO candidates and hurting market acceptance. The fickle nature of this cannot be remediated easily.
Geopolitical or financial shocks: There is always a “wild card” that external exigencies will derail the otherwise good venture-backed company fundamentals.
Conclusion: The Venture-Backed IPO Window Should Continue and Will Offer Potential Returns
This is not your father’s 2000 IPO market!
Macro-economic fundamentals remain strong. The market is rationally pricing venture-backed offerings. The pipeline of strong venture-backed pre-IPO companies is robust. The companies have significant revenues and growth, enter the public market later in their life, and represent a broad base and a diverse population across sectors (Consumer, Enterprise, Hardware, and Biotech).
Innovations have not stopped and new entrepreneurial realities have reduced the amount of capital needed to launch startups, and the venture industry has right-sized to adjust the flows of capital appropriately. With such a capital-efficient startup universe, new venture models such as angel investors along with renovated venture funds will continue to create innovative high-growth companies ripe for IPO.
We thus believe that the current momentum in the venture-backed IPO window will continue, short of any external world exigences.
[ii] Source: The Economist, February 8, 2014, The worldwide wobble
[iii] Source: Dealogic analysis
[v] Source: Source: Bloomberg Businessweek, March 6, 2014 http://www.businessweek.com/news/2014-03-06/ipo-dot-com-bubble-echo-seen-muted-as-older-companies-go-public
[vi] Source: http://techcrunch.com/2011/04/04/rocket-fue-160-million-valuation/
[vii] Source: http://techcrunch.com/2013/09/20/rocket-fuel-ipo/
[viii] Source: Renaissance Capital, 2013 Annual Review released on Jan 2, 2014. All data as of 12/31/2013.