How Much Is Your Outfit Worth?

It can be tough to tell where wishful thinking ends and reality begins. Look again, this time from the right perspective, and the mystery vanishes

By Gabor Garai

If you happen to head a venture-backed company and harbor visions of going public, there is a good chance you have wondered how large a price price your stock might command. The answer isn't as much of a mystery as some make it out to be, since it is determined primarily by three factors: the values of comparable companies in your industry, the technology or market advantage of your product within that industry, and the perceived quality of your management team.

In other words, the answer isn't that much different from when you were seeking venture capital backing and negotiating a valuation to determine what share of the company's stock the venture capitalists will receive. VCs want to know the valuations accorded similar companies, your relative competitive advantage and, of course, they demand to examine the management team in excruciating detail.


  What, you may ask, if my company is unique, or the first-of-its-kind in an emerging industry? Generally speaking, even when it seems as if there are no comparables, as in the case of Google's recent IPO, investors will find comparables in companies that are in a similar sphere. Thus, for Google (GOOG ), the main comparables were Yahoo (YHOO ), which is used heavily for searching, and Amazon (AMZN ), a heavyweight in the Internet arena.

A related question -- and a more important one than an outfit's uniqueness concerns its industry assignment. Certain industries command higher valuations than others. For example, software-development companies tend to be viewed as more promising than software-consulting companies, with higher price-earnings ratios. The reason has to do with how the companies garner their revenues. Consulting companies derive their revenues by hiring out professionals to work at client companies. They reflect the old adage about "hours worked are hours earned."

By contrast, software companies are perceived as developers of almost magical code that can then be duplicated at low cost, sold at relatively high prices, and in unlimited quantities. Indeed, there is now an "annuity" component to the software industry, popularized by (CRM ) and its successful IPO earlier this year. As software companies increasingly "rent" their software via the Internet, and thus dispense with messy packaging and marketing of upgrades, the lifetime value of a customer can often be higher than was ever possible under the old software model.


  The example raises another important issue for would-be public companies: demonstrating their uniqueness. As much as it is desirable to be part of an industry with the highest p-e multiples, it's also important not to be viewed as a me-too company. There should be an element to the business that is somehow unique and disruptive to an industry's ways of doing things. Thus, was able to position itself as a different kind of software company, a software company that was changing how the industry conducted its business, and how investors would view the software market.

The newly emerging companies in voice over Internet protocol (VoIP) face a more daunting challenge to go with their immense opportunities. They are part of the telecommunications industry, which hasn't been among the most robust performers since the Internet boom deflated. But they represent a disruptive technology on a scale rarely seen in that they have the potential to turn the telephone arena upside down and inside out.

Besides positioning themselves as part of the most appropriate industry, would-be public companies must also convince investors that their management teams have what it takes to achieve ongoing rapid growth. The top executives must be seen as energetic, creative, aggressive and, most significantly, having a record of success.


  Companies looking to go public need as much as possible to project that aura of success -- and one way to do that, beyond highlighting the capabilities of the top executives, is to recruit a board of directors that similarly projects a multitude of achievements, perhaps via star executives and even show business celebrities. Large corporations that have been public for many years often continue this process by adding retired sports stars or accomplished minorities to their boards.

The goal, then, in positioning your company for an IPO is to balance opposite sides of the same coin. You need to demonstrate that you have created a venture that is so unique and well managed that the upside potential is limitless, but at the same time fits into an established industry so it can be acceptably valued and sold to investors.

It's a difficult challenge, but if you have made it far enough to be considering an IPO, not terribly more difficult than many other outfits faced along the way.

Gabor Garai is a partner in the Boston office of the national law firm Epstein Becker & Green, specializing in the financing and growth requirements of small and midsize companies.

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