Until volatility in the market decreases, and confidence returns, the initial public offering window will not meaningfully reopen. When it does, a large number of companies will be competing for the attention of institutional investors. Data from Dealogic shows that the current IPO backlog — 144 deals, valued at $28.3 billion — is the highest year-to-date backlog since 2007. The opportunity to complete a successful IPO will, therefore, continue to be selective, and limited to the very best companies.
CFOs must prepare to fund companies for a longer time before an IPO. Research from SVB Analytics, a nonbank affiliate of Silicon Valley Bank, shows the time required for a venture-backed technology company to reach a successful exit is longer: the median time is now more than five years for software companies, and a significant number of hardware companies with successful exits in 2010 received their first institutional money in 2000 or earlier. Clearly, management teams and boards must consider alternative financing methods.
Expanding with Equity
When an IPO is not an immediate option, many companies have sought to tap private-equity investors. PE firms, including growth-stage venture funds, continue to be active, in spite of global economic conditions. For example, last year growth capital investments in software companies exceeded $4.3 billion and investments in hardware companies were just under $2 billion — the highest levels in a decade. We have also seen strong growth in secondary market transactions in private equity, although most of the activity appears to be founders and early investors obtaining liquidity for portions of their ownership positions. Still, this supply of capital may be available, and at an attractive cost.
Many U.S. banks, realizing in hindsight that their commercial and corporate lending portfolios performed relatively well during the financial crisis, are “doubling-down” in this segment. Banks pulled back on large, syndicated leveraged and investment-grade debt issuances in 2008 and 2009. That same market gained momentum in 2010, which continues well into this year. We see this in today’s syndicated debt market for middle-market transactions. Middle-market loan issuance reached $49 billion in the second quarter of 2011, a 32% increase quarter-over-quarter. Through the first half of 2011, nonsponsored middle-market loan volumes reached $86 billion, which is the strongest issuance level since the first half of 2007 and is on par with 2005 and 2006 levels (see Silicon Valley Bank’s Loan Market Review).
For senior debt with covenants, CFOs can obtain favorable pricing and terms. For example, online gaming company Zynga received a revolving credit facility totaling $1 billion from banks in July. This was the same month Zynga filed its S-1. (The deal has yet to price.) With one financing covenant, the interest rate for Zynga’s facility ranges from LIBOR plus 1.5% to 2% per annum, depending on consolidated leverage.
For other firms, growth capital and mezzanine financing may be a viable option. Pricing for no-covenant mezzanine debt facilities for technology companies is in the range of 10% to 15% per annum, with an average upfront fee of 1% coupled with a warrant to purchase shares in the company.
Wait and See
Of course, some companies will want to wait it out. Since the elapsed time between investment banker mandate and IPO pricing ranges from four to six months, it is hard to predict market conditions. As a result, many bankers are advising companies to file for an IPO now, realizing they may be able to price their IPO over the next few months and take advantage of the window opening. This is the “wait and see” approach and can be a good strategy to optimize the amount a company could raise in equity, should the window open as quickly as it closed.
Mike Selfridge is the head of regional banking for Silicon Valley Bank. He leads the company’s commercial-banking teams in the early-stage and middle-market technology and life-science practices.