Middle Market Deals and how to buy, sell and raise capital from $5 to $500 million

Omniture posted the following press release today:

OREM, Utah – April 4, 2006 – Omniture, Inc. today announced that it has filed a registration statement on Form S-1 with the U.S. Securities and Exchange Commission relating to a proposed initial public offering of its common stock. The offered shares will be sold by Omniture and certain stockholders of the company.

Morgan Stanley & Co. Incorporated will act as the sole book-running manager for the offering and Credit Suisse Securities (USA) LLC will act as co-lead manager. In addition, Deutsche Bank Securities Inc. and J.P. Morgan Securities Inc. will act as co-managers of the offering. The number of shares to be offered and the price range for the offering have not yet been determined. When available, prospectuses may be obtained from Morgan Stanley’s prospectus department at 1585 Broadway, New York, NY 10036-8200, by telephone at (212) 761-6775 or by emailing prospectus@morganstanley.com.

A registration statement relating to these securities has been filed with the U.S. Securities and Exchange Commission but has not yet become effective. These securities may not be sold nor may offers to buy be accepted prior to the time the registration statement becomes effective.

This press release shall not constitute an offer to sell or the solicitation of an offer to buy, nor shall there be any sale of these securities in any state in which such offer, solicitation or sale would

The National Venture Capital Association (NVCA) today released a report on the exit activities of member venture firms.  They reported just 10 IPOs among venture backed companies, raising $540.8 million, compared to 10 deals that generated $720.7 million in Q1 of 2005.

The number of M&A transactions was down from 46 last year to 43 this year, though the exit values increased in total from $4,364.9 million to $4,817.4 million.

Mark Heesen, president of the NVCA, expressed unease regarding the poor IPO activity:

We are becoming increasingly concerned about the economic implications of the lackluster IPO market for venture-backed companies.  Although we are bolstered by the continued strength of the acquisitions market, we can not rely on it as the only avenue to produce above average returns for the venture industry. Our economy depends on a strong US capital markets system to create jobs and revenues here. And while the companies that have gone public during the past year have seen their stock prices rise, their successes have not yet translated into a marked improvement in IPO activity. This situation needs to show signs of improvement before year end or we will begin to feel the effects on a much broader scale.

Ryan's comment suggested to me that I should add a bit to my comments about dutch auctions. 

Some have written that one of the big advantages of a dutch auction is that lower fees result.  Clearly, there is a lot I don't know, but I can't see how lower fees are inherent in this alternative process.  Well executed, I don't think there is much difference in the amount of work required--and therefore the costs associated--with one method of distribution over another.

In fact, the role of the investment banker is vitally important and should be well rewarded even in a Dutch Auction IPO.  For instance, we had a client a few years ago that spent in the neighborhood of a quarter million dollars preparing software and legal filings to conduct a self managed IPO.  Didn't work.  Period.

Note:  Paul Allen alerted us to the currency of this topic today, inspiring this post.

Dutch Auction:  A dutch auction is a long standing financial auction format, used for generations to price treasury auctions because it is such a fluid market.  Utah company Overstock.com was among the very first companies to go public using this method in 2002. 

Investment Bank W.R. Hambrecht has been the market champion for this style of public offering.

Basically, the offering works by soliciting from all interested investors, a price at which they would be willing to buy the offering.  These prices are then ranked in order to determine how low the bank has to go to sell all of the shares offered.

Bridge Loan:  A bridge loan in middle market parlance is typically a loan that is intended to help close the gap between current financing needs and a future round of equity financing.

Some angel investors are now using forms of convertible notes styled after common forms of bridge notes to provide seed stage capital to startups.  Later in their growth cycle, a bridge note may be used between venture capital rounds or as a bridge to an IPO, in which case the investment bank providing the underwriting will likely provide the bridge financing.

Some common features of bridge notes are that they typically convert to equity in the next round of equity financing.  Frequently a premium of 10 to 25% (I've heard of 40% but never seen it) is applied to the conversion such that the lender in the bridge gets better terms than the equity investors who fund the equity round.

In the absence of an equity round, the note may convert to equity punitively or simply become due and payable.

You may want to see what Investopedia says.

Recapitalization:  A recapitalization typically refers to a transaction in which the capital structure undergoes a radical change, including transactions that otherwise might feel like a merger or acquisition because it may result in a change of control.

For instance, a private equity firm may invest a sufficient amount of capital in a business to allow the company to purchase shares from exiting owners and executives.  A popular transaction in the last few years has been the private equity investment that allows the entrepreneur to sell some of her own shares to the company or the investor, allowing for the entrepreneur to keep her job and some ownership at the same time she creates some diversification in her portfolio--allowing her to take more risks and grow the business more quickly--potentially recreating the value sold.

Private equity firms have tried to give this style transaction a new name: private IPO.  With apologies to my private equity friends who use the term, I'm not sure that such an oxymoron is likely to better communicate the message than the term recapitalization.

Investment Bank:  As an investment banker, I've learned that most people in the middle market world don't have a clear understanding about what an investment bank does.

Most people do understand that large investment banks help take companies public, but may not appreciate what else they do or how they might help a company that is not seeking to go public.

Ultimately, a public offering (IPO) is means of accomplishing two objectives: 1)  create liquidity for owners and investors, and 2) raise capital to facilitate growth or reduce debt.

Middle market companies often seek to accomplish these objectives without an IPO.  Middle market investment banks can help to accomplish both by using private offerings to raise capital or mergers and acquisitions to help create liquidity.

Today, many private equity firms--who generally rely on intermediaries, including investment banks for deal flow--are willing to allow entrepreneurs to take money off the table at the time of an investment, accomplishing both of the objectives of the IPO without a public offering.

Investment banking firms are typically registered with the NASD.

There are two groups of people reading this post; I apologize to both of you because I'll try to take the time to write this post so as to be relevant to both groups.  One group knows what a reverse merger is and wonders why I suggest that you run away from it.  The other group wants to know what a reverse merger is and why I suggest that you run away from it.

For group two, a reverse merger is a merger between a private company, typically with a small but promising business, and a public company that has discontinued its operations, leaving only a "shell" with publicly traded shares.  The transaction is usually structured with the public company acquiring the private one and subsequently changing the name of the public company to the name of the private company.  Because the public company had no operations, it likely had no officers.  The private company officers become the officers and directors of the public company.  Voila, the private company is public without a public offering.  Oftentimes, a third party or parties, will contribute equity capital to the newly combined company to provide needed capital.

It sounds easy enough, so you ask, what's wrong with that?

In a political context, we talk about liberal and conservative, Democrat and Republican, Bush and Clinton.

In accounting, we talk about aggressive and conservative.  The traditional notion was that accounting entries that resulted in understating actual earnings were “conservative” and entries that led to overstating earnings were “aggressive.”  The question for entrepreneurs and executives might be, “which is best for maximizing the value of my business?”

The SEC and FASB (the folks who define Generally Accepted Accounting Principles or GAAP) view it as their primary objective to end this discussion in favor of being “simply right.”

Lorne Groe, a blogger who writes about things interesting to me, recently shared his thoughts on the scale (in revenues) required to effectively go public (in response to a query from me). 

He says, in summary, that on average tech companies have trailing revenues of $82.6 million with year-over-year growth rates of 39.3% prior to going public.  This is a great bit of information, for which I thank Lorne. 

He added the following: 

Here is what's interesting to me - based on my quick analysis of the current valuation multiples for the class of 2005, only 60% are trading above were they would have likely been sold.Here is what's interesting to me - based on my quick analysis of the current valuation multiples for the class of 2005, only 60% are trading above were they would have likely been sold.  So the question I have is why risk it?