How Ip Os Turn Pip Squeaks Into Players

The IPO has done magical things for many startups, and its appeal is as strong as ever

It was 1993, and Halsey Minor was on the brink of bankruptcy. The 32-year-old founder and CEO of Internet media company CNET Inc. had maxed out his credit cards, was $40,000 in the hole--and was ready to throw in the towel. "I was going to quit," he recalls. "I had no more credit, and no one would give me any more credit cards." Thanks to a last-minute cash infusion from a well-to-do friend, Minor escaped disaster, and his fledgling San Francisco-based operation survived.

And how. After CNET, with its snazzy delivery of computer and high-tech news, was rushed to the Web, it caught the attention of investment bankers. No matter that the startup lost $3.7 million on revenues of $1.7 million for the first quarter of 1996. In early July, the company went public--and into the welcoming arms of investors. Today, CNET has a market capitalization of $403 million and Minor is sitting on a personal fortune estimated at $72.9 million.

ULTIMATE HIGH. Almost anywhere else in the world, Minor's rags-to-riches tale would be extraordinary. But in Silicon Valley, where inital public offerings can transform paupers into princes and business seedlings into corporate redwoods, it's a way of life. Those three words--initial public offering--may be the most intoxicating in Silicon Valley. The IPO is the magical event that converts blood, sweat, and equity into cash--or at least publicly traded shares. And for many entrepreneurs and the venture capitalists who fund their ideas, it's the ultimate high.

And not just because it pads their bank accounts. Selling stock to the public gives cash-strapped young companies money to finance expansion, build brand recognition, and gain a new currency that can be used to entice employees or acquire companies. That's more important than ever in the age of the Net, where the goal is to get big, fast. Says venture capitalist L. John Doerr of Kleiner Perkins Caufield & Byers: "America's capital markets are a national treasure."

Treasure, indeed. Cisco Systems, Netscape Communications, and Oracle are legend for the legions of millionaires they have created. But how many millionaires are there at tiny Siebel Systems Inc., which before going public in June, 1996, used a folding table for the CEO's desk? The answer: 70, or almost a third of its 220-plus employees. Founder Thomas M. Siebel's 40% stake

in the sales- information software maker is worth $458 million today. And there are scores of newly public companies just like Siebel throughout the Valley.

The IPO is, to be sure, about money. But it's also a critical part of the delicate ecosystem that sustains Silicon Valley. How? The venture-capital firms and their investors make a bundle taking a company public. They pocket some of the money and plow the rest of those profits into the next generation of rising stars. Startups, meanwhile, use stock options to attract top engineering and management talent without having to lay out a lot of money up front on salaries. And when those options vest, it's not uncommon for employees to cash them in and use the proceeds to start their own companies. Or they may become angels themselves, investing in other tech startups.

HIGHFLIERS. With the stock market booming, many startups are skipping the later stages of private funding and heading straight for an IPO. Some 260 venture-backed high-tech companies nationwide went public in 1996, raising nearly $12 billion. That's more than double the 117 tech IPOs in 1991 and more than triple the $3.9 billion they raised, according to VentureOne Corp., a research group in San Francisco. Some of the highfliers in the IPO class of '96, including Yahoo! and Excite, were barely a couple of years old when they made their Wall Street debuts. Today, they account for a combined valuation of nearly $2 billion.

What do these companies do with their newfound fame and fortune? Online broker E*Trade Group Inc., whose employees danced into the wee hours of the morning at a party following the company's successful 1996 IPO, used the $46 million it raised to introduce new products and hire employees. It also spent heavily to beef up its brand name and keep pace in the fledgling market for Internet investing with such well funded competitors as Charles Schwab & Co.

Netscape Communications Corp., which turned a $5 million investment by Kleiner Perkins into a $255 million windfall by the end of its first day of trading, has been on a two-year spending spree since raising $148 million from its 1995 IPO. The Mountain View-based upstart has snapped up six companies and unleashed a barrage of new products to go head-to-head with software giant Microsoft Corp.

Two-year-old software maker BEA Systems went about things a little differently. While still a private company, it leveraged $50 million in venture funding from E.M. Warburg Pincus & Co. to buy up $140 million worth of businesses. It then used the $150 million it raised this year in the public markets to pay off the debt. The IPO "allowed us to buy the product and distribution and then to pay it off," says William T. Coleman III, founder and CEO of BEA. The unusual approach has paid off, too: BEA's sales have grown from $62 million last year to $30 million last quarter alone. Its shares have surged 283% since its April IPO.

Don't be fooled, though. Not all IPOs are successes. Most are volatile, and some can be downright dogs. General Magic Inc., a once hot maker of communications software, went public in February, 1996, long before it was profitable. After peaking at 26 1/2 on the first day of trading, the much-humbled company now trades at around 2. And of the four Internet search engine companies that went public last spring, for example, only Yahoo! has given investors reason to cheer. Lycos Inc. and Infoseek Corp. shares are trading at less than half their opening prices, while Excite hovers around its opening price of 17.

Truth is, most high-tech IPOs go south. A study by Broadview Associates LLC shows that high-tech IPOs in 1996 lost 8.4% of their value, compared with the firm's broader tech index and the Standard & Poor's 500-stock index, which logged 11.5% and 22.9% returns, respectively.

With this sort of track record, it might seem that investors would sour on putting money into high-tech startups or newly public companies. Far from it. Venture-capital firms pumped a record $6.3 billion into technology startups last year, according to VentureOne. And angels have become another major source of funding for fledgling companies. "There are dump trucks coming to Silicon Valley wanting to pour the money in," says J. Neil Weintraut, managing director at 21st Century Internet Venture Partners.

DISTRACTIONS. They won't all hit pay dirt. One in three venture-backed companies is a complete flop--and right now even brand-new Internet markets are looking pretty crowded with contenders. Plus, there is another downside. Going public can tax a company's management resources and distract employee shareholders. "When the stock price goes down, they're depressed. And when the stock price goes up, they're euphoric," says Netscape co-founder Marc Andreessen.

That's why a growing number of companies are sidestepping the IPO process entirely, choosing instead simply to sell to one of the big players that are constantly scouring the field for promising new technology. Microsoft, for example, has spent more than $2.5 billion in the past four years on 57 acquisitions and partnerships. This year alone, it has acquired six companies, including the $425 million purchase of WebTV, a two-year-old startup that makes a system for Web surfing from your TV. Meanwhile, disk-drive maker Seagate Technology Inc. made the founders of 15-month-old Quinta Corp. happy when it recently paid $325 million for their company, which is working on next-generation disk-drive technology. Quinta had yet to develop a product or earn one penny in revenue.

For those that want to go public, meager, even nonexistent, profits need not be a barrier. Netcom On-line Communications Services Inc. proved that, and it started a movement that hasn't let up. In 1994, the Internet service provider lost $100,000 on revenues of $12.4 million. Still, its December, 1994, IPO was a hit. The shares were priced at $13, above their initial filing range of $10 to $12, and were soon trading at over $20--setting off a speculative frenzy around Internet stocks. These days, Netcom shares trade in the mid-teens. After Netcom, says Weintraut, "you merely had to suggest you would be profitable in the future."

Then came Netscape. When the company went public in August, 1995, it was just 16 months old and had pulled in $16.6 million in revenues for the prior six months. Profits didn't come until later. Yahoo!, Excite, and CNET were all losing money at the time of their IPOs, too. Most Net startups still are--by design. CNET's Halsey Minor maintains that Internet media companies like his could see profits much more quickly than traditional media properties; magazines such as Entertainment Weekly and cable networks such as MTV have taken several years to turn that corner. However, he says, in the rapidly developing Web market, it's wiser to forgo profits in the short term to build up market share.

Investors are buying into the logic. CNET's shares are up 62% from their IPO. E*Trade is up 184%. And some of this year's crop are sizzling, too. Despite continuing heavy losses, shares of @Home, a cable-based Internet service, have jumped 110% since its June 30 IPO. Shares of Rambus Inc., whose technology speeds computer performance, have surged a stunning 450% since May, making it the year's best-performing new offering. After Yahoo! turned in solid revenue gains and--gasp!--profits, investors have bid up its shares by more than 300% in just 15 months.

Of course, there's always the old-fashioned way: build up a track record of revenue and profit gains before taking the plunge into the public markets. Some startups, such as Marimba Inc. and Crossroads Software, are doing just that, and industry watchers expect a strong lineup of IPOs next year. If that's the case, the Silicon Valley machine should keep humming along.