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Something is rotten in the state of Silicon Valley
Investors debate reasons for IPO slow-down, worst in decades

by Arden Pennell

In a rousing panel discussion littered with four-letter words — "tech" being perhaps the mildest — investors debated causes of the sorry state of Silicon Valley's venture economy at Stanford University last week.

While panelists didn't agree on the roots of troubles, they said things are bound to improve — sometime.

A main point of contention was whether federal regulation, the Sarbanes-Oxley Act of 2002, is to blame for the economic slow-down.

A crucial artery of the Valley economy, venture capital has had a weak pulse recently. Not a single venture-backed company filed an initial public offering (IPO) in the second quarter of 2008, according to the National Venture Capital Association.

That hasn't happened since 1978, according to the group's study.

Venture firms — such as the many in downtown Palo Alto and lining Sand Hill Road — rely on IPOs, as well as mergers and acquisitions, to profit from companies in which they've invested.

So the tone was part joking, part dismayed, as industry members attempted to self-diagnose what could be causing market doldrums.

Speakers included a going-public "caddie" who helped orchestrate the Google IPO as an employee, an investment banker who sold the kids' social-networking Web site Club Penguin to Disney for $650 million, and Morgan Stanley's head of West-Coast technology investments.

The talk was part of the larger Summit at Stanford to study technology trends, sponsored by media company AlwaysOn and the school's entrepreneurship program, the Stanford Technology Ventures Program.

So far, theories on causes of the weak market include hesitant investors, shockwaves from the mortgage crisis, and costs associated with the Sarbanes-Oxley Act, the regulatory legislation created after major firms such as Enron were exposed as financial frauds, according to a survey from the venture group.

But those theories didn't always square with panelists.

Faulting federal law for Silicon Valley's current financial woes is misplaced — blame the venture capitalists themselves, according to Paul Deninger, vice chairman of investment bank and securities firm Jefferies & Company.

"I'm so sick of hearing about Sarbanes-Oxley," he said.

Rather, the problem is the venture-capital community, which refuses to invest early in infrastructure such as accounting systems that will meet the Act's stringent requirements for companies they're funding, he said. When it is time to contemplate going public five years down the road, they are saddled — unsurprisingly — with huge costs, he said.

"If you build a house and forget to put in plumbing ... that costs a crapload of money," he said. He added that he'd fought Sarbanes-Oxley in Washington, D.C. and it's time to move on.

The act, which is named after its sponsors in the Senate, is also called the Public Company Account Reform and Investor Protection Act. It established a national oversight board for all public companies and introduced greater requirements for financial reporting and auditing — meaning, some say, more work for companies deciding to go public.

Lise Buyer, the Google veteran, said companies unable to handle the hassle and $2 million to $3 million cost of Sarbanes-Oxley weren't ready to have an IPO, anyway.

Yet the act has posed a real barrier, according to Jamie Montgomery, CEO of Los Angeles-based investment bank Montgomery & Co. and a leader of the Club Penguin deal.

"Sarbanes-Oxley has put a permanent damper on IPOs," he said, forecasting, "this is going to be a tough year." Things will likely take another 18 months to look up, especially in the currently weak financial markets, he said.

While speakers largely declined to answer the ostensible question at hand — that is, when exactly tech IPOs and mergers and acquisitions will rebound — they offered a bird's-eye perspective on present-day investing.

Tech is all grown up, said Drew Guevara, a managing director at Morgan Stanley.

"We live in an age of diminished expectations in technology IPOs," he said. In the mature market, it's harder to make a big, splashy entrance and become the new Google, he said.

A software firm nowadays must decide whether it wants to be acquired by a current giant such as Hewlett Packard — or strike out on its own to an IPO, according to Guevara.

Of course, that's problematic when there are only a handful of big companies buying startups and smaller firms, Deninger said. In a recent study of acquisitions, his firm found there are only 10 major purchasers — one of whom, Yahoo, may not be around for long, he said.

"We have to repopulate the buyer base," he said.

Despite gloomy assessments, a slight silver lining could be detected.

A tough market is an opportunity for organizational soul-searching, Buyer said.

"Are you a feature, a product or a company?" she asked. The former two should be acquired or merge; the latter may want to IPO, according to Buyer, a principal at Class V group, which guides companies through public offerings.

Buyer also recommended using a sturdy rudder of common sense to steer through rough times.

"Build something that somebody wants and will pay you more than it cost you to build it," she said.

Another dose of pragmatism came from audience member Francine Hardaway. Hardaway runs Stealthmode Partners, an entrepreneur-coaching company based in Phoenix, Ariz.

Down in the desert, there's not nearly as much venture funding as in the Valley, she said. Her group helps many nascent companies bootstrap, or find funds themselves, until they attract enough customers to profit.

In contrast, there's a notable expectation in cities such as Palo Alto and Menlo Park that cash should be always free-flowing, she said.

"There's this sense of entitlement to money in Silicon Valley," she said. She wondered aloud: Whatever happened to companies funding themselves — then profiting from hard-earned success?

Staff Writer Arden Pennell can be e-mailed at apennell@paweekly.com.