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Staying Private Instead of Rushing into an IPO

by Bronwyn Fryer

Roger Greene, the president, CEO, and founder of Ipswitch, a nine-year-old company in Boston that makes Internet network-management software, wears the shadow of an “I told you so” smile these days. While publicly traded companies such as and are writhing under single-digit stock prices, Greene’s very private company has snubbed the notion of an IPO and is ticking along successfully, with profits of 29% annually. It’s a goal that even is still far from attaining. That’s because Greene has found plenty of expansion capital outside the public markets to help his business grow. This is a strategy more CEOs are adopting.

What a difference a stock market correction makes. Last year, it seemed that every dot-com on the planet (including those with the most vaporous business plans and mediocre revenue and earnings prospects) was going public. But when the Nasdaq took its April nosedive, it was like turning a searchlight on an orgy. Of the 73 companies that went public in the first quarter of 2000, 43 slipped below their offering prices.

“Currently, there are 9,600 public companies out there trading at less than 15,000 shares — that’s nothing — a day,” says Paul Schaye, a partner with private-equity firm Chestnut Capital Partners of New York City.

“One main reason for this phenomenon is that many of these companies went public too soon. They should have waited until they shored up their balance sheets and had at least a year’s history of profitability.”

Since then, getting a ticker symbol attached to one’s company name is no longer de rigueur. According to Venture Economics, 47 companies withdrew or postponed their IPOs between January 1 and April 25 of this year. Instead, these companies are focusing on business fundamentals and using a host of other means to raise expansion capital until they are ready for the public arena. These means include securing late-stage angel financing or venture capital, and getting cash from corporate strategic partners. A few are also funding their operations the old-fashioned way — by earning it and reinvesting cash flow into the business.

For companies that are not capital-intensive businesses, such as software maker Ipswitch, going it alone and bootstrapping makes a lot of sense. Greene has slowly built his software —development company by funding everything — from R&D to new hires — with cash generated by profits. For the first four years, he didn’t take a salary, reinvesting 100% of the profits in the business. Even his software developer worked on spec and with the promise of royalties on later sales.

Ipswitch’s products start at $49 and sell to a broad audience. Although the company won’t disclose revenues, its monthly profit margin can be as high as 25%. Greene has chosen to stay private even though VCs come courting all the time. He never wants to give up equity and do an IPO. “When you’re a public company, you lose your focus on the business because you’re tracking the stock price,” he says. “I like the freedom to grow the business and invest where I see fit.”

Over the years, his independent-funding tactic has worked splendidly. During Ipswitch’s first four years in operation, it broke even despite the fact it reinvested its earnings in R&D, marketing, e-commerce infrastructure, and customer service. Investing in all these programs, however, has paid off handsomely: During the past five years, it has seen an astounding 916% growth rate.

Of course, not all companies are software developers with overhead consisting of intellectual capital. Some companies, particularly ventures that need to grow quickly or expand resources to handle large projects, are much more capital — intensive and need outside infusions of cash. That’s where angel investors — wealthy individuals who typically contribute thousands, even millions, to private companies — come in. Although in the past such financial patrons were interested only in backing startups, recently many are willing to band together to form an entrepreneur’s idea of late-stage financial heaven.

Consider the case of Dave Berkus, managing partner of Berkus Technology Ventures in Arcadia, Calif. The company manages several angel investment funds that make seed-capital and late-stage venture investments in Internet and software businesses in Southern California. A former entrepreneur who ran a software company called Computer Lodging Systems, Berkus understands the needs of private companies with potential.

In 1999, Berkus and a group of seven high-net-worth individuals banded together to offer $230,000 in equity capital to EPC International, an 18-year-old, debt-laden software company whose president and CEO had died suddenly at the age of 32. To save the CEO’s heirs from bankruptcy, Berkus gathered his angels together for the late-stage investment. The money has helped recharge EPC, whose sales have jumped from a faltering $250,000 annually to an estimated $5 million in 2000. The investor group’s projected return: 100%.

Securing venture capital is, of course, the preferred option for companies that see themselves on the IPO or acquisition track and that need larger amounts of money to get there. Right now there is lots of venture capital available. Last year, the industry raised more than $43 billion.

Companies with solid business plans and exciting prospects for growth — which have already secured first and second rounds of venture capital — can pursue subsequent rounds of financing, called mezzanine financing. If your initial offering was in the works and is now on hold, mezzanine financing will pull you through until the market gods smile again, says venture capitalist Ann Martin of Rosewood Partners, in San Francisco.

Contrary to popular belief, not all VCs want a quick exit, nor do they make demands that a portfolio company go public too soon. Jon West, CEO of Cimlinc Inc., a 19-year-old software maker in Chicago, can attest to that. Kleiner Perkins Caufield & Byers has helped him raise $24 million in exchange for 70% equity in five rounds of financing. Now it’s helping him do yet another mezzanine finance to raise $15 million by year’s end. The goal is to help fund development of Cimlinc’s software used by factory workers in the airline industry.

How did West keep his VCs so patient? By working with them to develop a long-term strategy to grow and build. “They realize we can’t go public until we have a long profit record,” he says. With $18 million in sales, West expects that goal will be met soon.

Along the way, West has bumped into another financing source often overlooked by entrepreneurs: corporate VC investors. Many Fortune 500 corporations are eager to fund entrepreneurs to get access to their know-how and technology, or to secure a profitable business relationship. Over the years, West, for instance, has attracted $3 million from his reseller in Japan, Nisho Electronics. What was great was the fact that the deal was structured as a convertible debenture, so West was able to get his stock back and not give up any equity.

The flexible financing terms that can be arranged with corporate strategic partners are the attraction for entrepreneurs. That’s why Elliot Cooperstone, the 38-year-old CEO of EmployeeMatters (, is trying to forge an alliance with MasterCard’s small business portal. Under the agreement, Cooperstone would provide his payroll/benefits solution in exchange for MasterCard’s participation in a $30 million mezzanine financing now being arranged by his VC firm, Frontline Capital. “Besides getting money, I’d be getting one of the best customers I could ever have,” says Cooperstone, who is excited by the prospect. “Staying private has its rewards.”