Is the bar lower for a tech IPO?

I am not sure if you saw the news, but Salary.com recently filed for an IPO to raise up to $50 million. On the book is Thomas Weisel Partners, William Blair, Needham, Pacific Crest, and Wachovia. According to the S-1 filing:

Salary.com is a leading provider of on-demand compensation management solutions. Our comprehensive on-demand software applications are integrated with our proprietary data sets to automate the essential elements of our customers’ compensation management processes....

In addition to our on-demand enterprise software offerings, we also provide a series of applications through our website, which allows us to deliver salary management comparison and analysis tools to individuals and small businesses on a cost-effective, real-time basis...

We offer our solutions principally on an annual or multi-year subscription basis. Our direct sales group markets and sells our solutions primarily using the telephone and web-based demonstrations. From the introduction of our solutions in 2000 through September 30, 2006, our enterprise subscriber base has grown to approximately 1,500 companies who spend from $2,000 to more than $100,000 annually, including companies such as Wal-Mart, Home Depot, Procter & Gamble, Merrill Lynch, UPS and Cisco Systems. We also sell to both individual consumers and smaller businesses through our Salary.com website.

From April 2001 through June 30, 2006, we achieved 21 consecutive quarters of revenue growth. During the years ended March 31, 2004, 2005 and 2006, we achieved positive operating cash flows of $0.3 million, $0.9 million and $1.8 million, respectively, and used $0.7 million of cash in the three months ended June 30, 2006. During these periods, we have consistently incurred operating losses, including $0.8 million for 2004, $1.9 million for 2005, $3.0 million for 2006 and $0.8 million for the three months ended June 30, 2006. As of June 30, 2006, we had an accumulated deficit of $21.8 million.

I would usually put IPO filings in the nonevent category but as I dug deeper into the company and financial performance, it did raise some interesting questions for me.  First and foremost, the traditional rule of thumb that most investment bankers have quoted me in the last couple of years was that in order to go public a company needs to have an annual run-rate of $40-50mm of revenue and a couple quarters of profitability.  While the Salary.com numbers are strong (read the S-1 here), they are not close to those metrics.  In fact, during the last 3 fiscal years for the company, it did $6.4mm, $10mm, and then $15mm in revenue.  The trailing twelve month number is closer to $20mm in revenue.  While slightly cash flow positive, the company is not GAAP profitable.  So the natural question for me is to ask whether or not the barrier for a private company to go public is much lower today and whether or not this will signal an ongoing trend in the future.  This is obviously relevant for a number of reasons.  Outside of a few outliers, most of the returns generated for VCs have been from M&A transactions.  If the IPO markets open up again, it would give investors and entrepreneurs another option to create value.  Using a back of the napkin analysis, most companies sell about 20% of their stock to the public, so one could assume that Salary.com is valued at around $200mm pre-money implying a 10x multiple on trailing twelve month revenue.  I must say that sounds quite appealing.  Anyway, we should all watch this company as it goes through its paces because if it does well, it could open the door for plenty of other companies like it.  There must clearly be an appetite from the institutional money managers who are looking for more upside from rapidly growing small cap companies.  By the way, one other interesting point about Salary.com is that is an on-demand application play with some web-based advertising thrown into the mix.  It is also mostly a subscription-based business which means it has a highly predictable revenue stream which is great for forecasting future performance.  Finally, the company only raised $5mm of VC dollars so it is highly capital efficient.  If you read from the S-1 above, most of the sales are generated through the telephone or through web-based demos, all of the traits for a nice frictionless sale and great business model.

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This post was written by who has written 358 posts on BeyondVC.

7 Responses to “Is the bar lower for a tech IPO?”

  1. Ed Snow Nov 17, 2006 at 1:57 pm #

    Ed, interesting stuff as ever, I’d just comment that with a subscription business model in software the revenue ‘quality’ is higher as you say but also the way in which the revenue gets recognised is different so, for example if the revenues were restated in traditional license terms they are likely to be higher I’d guess so perhaps the bar is still roughly the same?

  2. Mark S Nov 17, 2006 at 2:37 pm #

    Frankly, I think it’s refreshing to talk about issues like say revenue, cash flows, GAAP profitability, and capital efficiency. What has me personally disgusted is the prevailing climate which isn’t concerned with any fundamental business metrics. The notion to just “build something with value” and worry about making money in the distant future is a great idea…as long as it’s not my money you want to invest ;-)

  3. b Nov 18, 2006 at 8:11 pm #

    Yes. But look at who the banks are.

    This will be a tough deal to get done. A ~$40M offering (or whatever it ends up pricing at) is simply not big enough to attract decent, if any, institutional investors.

    My guess is that this thing sits on file for 6+ months.

  4. Matt Nov 20, 2006 at 2:09 am #

    In the current regulatory environment, going public just means a permanent acquisition of deadweight recurring expenses in exchange for a one-time infusion of cash. Few companies with any other legal option see this as a good thing.

    This is an entirely natural reaction to present reality, but it _is_ going to mean that investment bankers are going to be more hungry for deals than they have been in the past, because companies that would have IPOed if they’d been at the right stage before SOX are now all scrupulously avoiding any hint of contact with the public markets. And if investment bankers are hungry for deals, their traditional requirements before doing one are going to be relaxed, at least in certain cases.

    Doesn’t mean the market will bite, though.

  5. Kris Tuttle Nov 20, 2006 at 1:07 pm #

    It is a new point on the curve towards an easier time in the IPO space. It’s true that a $20M subscription business is kind of like a $50M license business.

    However it could also be a filing designed to start the M&A process instead.

    Definitely one to watch.

  6. Grant I’m sure that it isn’t happening anytime soon, it would be nice to see it become a little easier for smaller companies to raise capital from public equity markets.

Trackbacks/Pingbacks

  1. The Ponderings of Woodrow - Nov 20, 2006

    Ed Sim asks, “Is the IPO bar being lowered?”…I sure hope not

    Those who cannot learn from history are doomed to repeat it — George Santayana____________________________________________________________________________ Ed Sim has a thoughtful post about Salary.com and its plan to come public. I would usually put I…

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