Venture Capitalists Viewing Net IPO Shakeout as a Return to Quality

Any development that keeps weak firms from sucking up capital stands to be a positive, executives say.
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SAN FRANCISCO -- Down on Sand Hill Road, Silicon Valley's venture capitalists aren't bemoaning the lackluster demand for this month's Internet IPOs. In fact, if the latest pullback serves to deter weaker IPO hopefuls from consummating their plans to go public, venture capitalists are applauding.

In their view, the frenzied IPO market in 1999 has allowed too many immature or just plain dubious Internet enterprises to suck up precious capital. And that's not good for anyone, VCs say, including the dogs that get to see the light of day.

"Over the past few months, the screen has gotten much wider," says Andrew Anker, a partner with

August Capital

, which manages two tech-focused funds worth $300 million. "A lot more of the bad companies have come out. If the screen tightens a bit more, then it could make it harder for some of these bad companies to continue to come out."

To judge from Wednesday's

dissing of new Internet offerings, the screen does seem to be tightening. Two of the five Internet IPOs that began trading Wednesday,

Juno Online

(JWEB:Nasdaq) and

ZipLink

(ZIPL:Nasdaq) fell 11% and 12%, respectively, from their offering prices, the first time two or more Internet IPOs closed below their offering prices on their first trading day.

"We're hitting a crescendo right now," says Randall Roth, senior analyst at

Renaissance Capital

. "The activity is enormous, and everyone's trying to move product before the door slams shut."

As of Wednesday, 59 Internet companies had gone public in 1999, raising $4 billion, according to

Thomson Financial Securities Data

. That compares with nine offerings raising $511 million during the same period last year. And the trend continues. Since March, 77 Internet companies have filed for IPOs, up from 12 such deals filed in the same period in 1998.

"We already had an enormous backlog, and now there are more deals coming," says Roth. "A lot more deals are going to be stuck in IPO purgatory."

Jim Breyer, a managing partner with

Accel Partners

in Palo Alto, Calif., has also noticed a predilection among company directors of Net start-ups for going public earlier. This trend troubles Breyer, whose firm manages $800 million.

"This is an extremely dangerous perspective," argues Breyer, "because it creates an enormous backlash against private companies that are of high quality as well as public companies that are building high-quality franchises, including companies like

Yahoo!

(YHOO)

,

RealNetworks

(RNWK) - Get Report

and

eBay

(EBAY) - Get Report

."

A particularly patient lot, VCs function like farm teams for capitalism, nurturing start-ups for five to 10 years before cashing out in IPOs or buyouts. In that sense, a VC can provide a useful perspective on the health of adolescent companies that may or may not mature to become the next eBay.

Despite the lackluster reception for some weaker IPOs, most VCs see continued demand for the stronger Internet public offerings. "I think we'll have a pretty good IPO environment moving through the fall," says Ruthann Quindlen, a partner with

Institutional Venture Partners

, a VC firm based in Menlo Park, Calif., that manages more than $1 billion.

Quindlen, who describes herself as "cautiously optimistic" about the IPO market, says she continues to see a lot of good e-commerce deals come across her desk, especially in the market for business-to-business services. She is less bullish about investing in Internet tools, semiconductors and enterprise-software firms.

The Internet Capital Vacuum
Venture-capital investments in Internet companies

Venture capitalists are increasingly tying their fates to Internet start-ups. During the first quarter of 1999, Internet-centric companies received $2.1 billion out of $3.6 billion in venture funding, according to research firm

VentureOne

. In the previous quarter, Net start-ups consumed $1.6 billion of the $3.1 billion in venture capital invested.

So far, this quarter is looking even stronger. "There is still a perceived great opportunity in the Net despite the volatility of the public markets," says Jean Yaremchuk, vice president of research for VentureOne.

Some venture capitalists, such as Breyer, are advising companies in their portfolio to slow their entry to the public market until they achieve greater visibility and a stable track record. Going public can create serious problems for a start-up, says Breyer. Recruiting top-level management in a post-IPO environment can be tough, as can shifting strategies once Wall Street expectations are set.

Still, Accel has not shied away from taking its companies to market. Breyer says four Accel-backed companies have gone public this month, and he expects another four to come out by this summer. Several of the companies Accel has brought public, including

Redback Networks

(RBAK)

and

Mpath Interactive

(MPTH)

, posted spectacular first-day gains. But Breyer is not taking those performances for granted.

"I can remember not too long ago when a 3- or 4-point gain was considered a huge success," says Breyer. "We are in an insane period of time where the expectations are utterly unrealistic."