Thursday, October 10, 2013

One the Dearth of Women Qualified to Serve on Public Technology Company Boards

We were delighted to have this bit of commentary published on the allthingsd site today, and while it swerves from our other posts slightly, it does fit in with the "Things to think about for public or soon to be public companies...

Seeking Qualified Women for Board Seats - Like Trying to Find a Needle in..... well, like Trying to Find a Needle in a Sewing Kit....

"Dick Costolo, Twitter’s chief executive, has prioritized finding a woman to be on the board, but has found it difficult"
“The issue isn’t the intention, the issue is just the paucity of candidates.”
"...the pool for board-qualified women in technology is shallow..."

"There is definitely a s supply-side problem." So asserts Twitter's Chief Technology Officer, Adam Messinger when asked about women on boards...

New York Times  October 5, 2013

Wow.  Where to begin?

Let's start with a fact: there are fewer women then men who write and debug software code for a living. No denying that. 

Now an observation: having been in many, many, many board meetings over the years as a director, and other times as an advisor, I have never, not even once, been in a meeting where at any time, even for 5 minutes, any board member of any gender was asked to give a company directive in machine language, scratch out a decision policy in Ruby on Rails or for that matter, code anything at all in any language. 

Most of the meetings I have attended have called on board members to ask questions, make introductions, discuss potential acquisitions or acquisition inquiries and most importantly to debate and discuss product strategies, marketing plans, management challenges, compensation structures, financial progress, financing options, investment decisions, how to deal with Wall Street and short and long term business goals.  

None of these topics requires a CS degree or years in the CTOs office. Tech companies may well choose to have some engineering prowess on the board, but companies with nothing but technical directors will in all likelihood lose out to companies strategically advised by those with a diverse set of opinions, perspectives and experiences. 

The problem isn't a "shallow pool" of qualified candidates; it's a dearth of high-profile individuals with the right skill set.  The real question is how many companies are building boards to provide actual advice versus how many are looking to put impressive, "A-list" names on a list.  Sure, it would help any organization to have Marissa or Sheryl on the board, but as genuinely gifted as those two leaders are, they are not the only females in the Valley with demonstrable talent for thinking strategically, solving problems creatively, analyzing financial performance, negotiating terms and perhaps most importantly, assessing management skills.

The blame for misguided myopia does not rest solely with management teams of tech companies, or even with their existing boards. The problem, or the "need a rock star" mindset is pervasive in the executive recruiter industry too. Willingness to consider a proven executive who doesn't already sit on a board is hard to find. 

Speaking from personal experience, I was fortunate enough to be a board member and committee chair for a NASDAQ listed company some years back. During that time, I received multiple inquiries about my interest in joining other boards but as the first one required a substantial time commitment and as I had a day job, I declined.  Eventually our company caught the attention of a few private equity firms and then some strategic partners as well. After a period of active negotiation and a resultant significant bump in the price, we were acquired in what all considered a very successful exit.  Post the dissolution of that board, my name fell off the "active director" list and the board inquiry hotline went silent.  I relate all this only as one first-hand view of how the board selection process often works.

Women aren't on boards in Silicon Valley because the half dozen who regularly get the call are busy and no one is asking the rest.   Yet far from shallow, the actual pool of viable candidates is deep with Comes, CFOS, those with capital market expertise, product managers, general managers and a whole host of others who could bring talent, perspective and useful know-how to any board.

That said, not every company needs representation from every demographic.  Selecting a board just to get the right mix of faces for the annual report photo is a disservice to investors and management alike.  When Facebook came under pressure for having an all male board, it was truly a tempest in a teapot. Mark Zuckerberg had clearly surrounded himself with a management team packed with powerful women charged with actually running various aspects of the business on a day-to-day basis.  That inarguable fact coupled with the company's dual-class stock structure that insures that the board can offer opinions, suggestions and guidance, but has no real decision making power, made the howling for a women representative on that board a distracting sideshow.

However, companies run and advised by a heterogeneous band of brothers and those where the board vote really can swing policy are quite different.  In those cases, it's not OK that the existing board looks the other way with a shrug proclaiming that it's too hard to find talented candidates. 

Repeating: none of this is to say that every single board needs representation from both genders or from every other demographic profile. What is being said is that those companies that claim to want to diversify, particularly those with products that are as often used by one gender as the other, should try a little harder. The gentleman doth protest too much, methinks.

A company that actually wanted too could fix the problem in no time by hiring talent, not title.

Thursday, August 15, 2013

Analysts and IPOs... Here We Go Again

Analysts and IPOs - (We apologize for the length of this post)

In the background since the 2004 consent decree, analysts and banker selections are again making news (New York Times Dealbook, Suzanne Craig and Peter Lattman, August 11, 2013) and not in a good way.  This renewed scrutiny is:

a) Not a bad turn of events at all - particularly given some rumors of very bad (analyst pressuring) behavior on the part of those working with the large private equity-backed IPOs.
b) Not as clear cut as it may seem at first and
c) Probably just another bonus unintended consequence of the JOBS act, which encourages, or at very least now allows, conversations to between issuers and analysts in the middle of the IPO preparation process, while ignoring the constraints of the aforementioned consent decree.

Reasons why bankers and analysts should not work together on potential IPO candidates. 

It all boils down to this; bankers are generally paid on quantity, some combination of the number of deals done and the count of dollars raised.  With this sort of all important (bonus determining) performance measure, pragmatic bankers have every incentive to pursue as many reasonable transactions as possible.  This is generally possible because when they finish one deal, they are on to the next.  There are only limited, on-going time commitments to the now-public client, at least until it's time for a secondary or some M&A.  Please note, we are not implying that bankers don't care about the quality of the companies they take public; they do care as each success can be leveraged into new mandates. Nonetheless, assuming a reasonable quality screen, quantity matters most of all.

Analysts on the other hand, generally earn their bonuses based on the quality of their work.  A strong - or weak placement in the various buyside investor polls like the detailed Greenwich Associates poll or the more far-reaching but less precise Institutional Investor poll can have an enormous impact on the annual take-home pay of an analyst. That reality has two implications.  First, on an ongoing basis, analysts need to keep investors accurately informed about the goings on in the industry and at each particular company.  That service requires a very definite time commitment.   Additionally, analysts need to be selective about which companies they cover, as their obligations are on-going and cumulative.  Writing detailed research on stocks about which investors care little will not garner enough bonus generating votes to be worth the effort.  Said succinctly, bankers would like analysts to cover more and more and more companies.  Analysts, should they aspire to keep their audience of investors/voters, have to be credible and need to enforce a quality screen and can not over commit.

Here is where the plot thickens: bankers directly generate revenue for their firms while analysts, most directly are a cost center, generating revenue for the home team only indirectly via the trading desk or banking wins....

Why shouldn't analyst be involved in the banking process?  Because bankers have every incentive to pressure analysts into agreeing to cover a company, whether or not the analyst is genuinely enthusiastic about the prospect.  Analysts, well aware that as a cost center, every "NO" has negative short term P&L implications for their employer, clearly feel that pressure.  In a business beset by routine layoffs, no one wants to be the Little Engine that Couldn't.

The solution?  Keep analysts out of the banker selection process to eliminate this sort of pressure.


Reasons why analysts and bankers need to work together on potential IPO candidates.

It all boils down to this: If an analyst is not impressed by a company or a segment of a larger industry, if the analyst is not inclined to stay involved with a newly public company, then that analyst's bank should not attempt to sell that IPO to its investing clients.  Period.

Therein the problem: if the analyst doesn't meet with the prospect before the banker selection process, how is he or she to evaluate the potential issuer's opportunity and decide whether or not the new company is worthy of ongoing coverage?

Furthermore, if a potential issuer has not met with an analyst, it can not be comfortable that the analyst understands the company's story and potential. These meetings are not about eliciting a "Yes, I will recommend this stock"! statement.  They are exploratory two-way evaluations that can be very valuable to analysts both because they learn about new products, services and companies, and because they gain a better understanding of what competition is coming round the bend for the existing public incumbents.  Analysts who met with a private Workday long before it's bakeoff were able to raise yellow flags for investors in Oracle or ADP to pay attention to this new competitor.  That is exactly why analysts are helpful to investors; they exist to gather and distribute a deeper level of insight.  Denying analysts the chance to meet with private companies would hurt all investors.  Yet there can be no doubt that those early meetings are about gaining both insight in the industry and favor for their banks: favor that should hopefully place them on the banker selection short-list when it comes time for the lucrative public offering.

But wait, there's more. These private company, pre-IPO meetings matter not only to bankers and analysts but also are critical for investors. When it comes time to make the "invest" or "pass" decision on IPOs, one of elements buyside investors consider is how well they will be able to track the changing fortunes of the new issue.  Analyst coverage is a very important element of that information flow.  If the buyside can not be sure that someone they respect will be covering the stock - covering does not mean perpetually recommending - then the risk they take in buying a new issue increases dramatically.

There are clear conflicts of interest between parts of investment banks when it comes to IPOs and yet, should analysts be completely excluded from the IPO process, bankers, analysts, issuers and investors would all be meaningfully less informed. No one but litigators would benefit from that arrangement.

Thursday, July 11, 2013

Part II - The back five of our Common but Easily Avoidable Mistakes list

Oh ye of little faith.  Here you were thinking we were only offering up Part 1, when in fact we just figured we should give everyone time off for the Fourth.  On with part two:  Items 6 through 10 of mistakes newly public companies should really - no REALLY.  try to avoid.

 If at all possible, do not:

6.       Change your story:  If you go public as a SaaS provider with predictable earnings, do not even think of repositioning to be a mobile, big data play because those multiples are higher, or for any other reason.  Investors will be rightly alarmed if during the first couple of quarters as a public company, a recent IPO:

o   Changes the model or strategy communicated during the roadshow
o   Changes management or
o   Makes a major acquisition (with exceptions)

Early changes to the business model or strategy communicated during the IPO scare investors.  They took of leap of faith and invested with your risky offering of a new issue because they literally bought into the story you told on the road.  Not surprisingly, they expect you to stick with that plan now that their money lines your company's bank account. 

Investors also expect companies to have the right executives in the right seats before the IPO.  Swap a key player out too quickly and your new shareholders will cover the field with yellow, if not red, flags, reasoning that early changes signal big problems.   The same often, although not always, applies to material acquisitions in the early going unless a) you were clear in the S-1 that acquisitions were a likely use of funds or b) you can make a very strong case for why the move is brilliantly opportunistic.  Don't let your new investors think that their money is burning a hole in your pocket, or that you are taking your eye of the main business.  Know that even though they bought at the IPO, they are not really invested until they see several quarters of consistent, "as billed" performance.

In the words of one top institutional shareholder with whom we recently spoke,  “the first 6 months are the honeymoon.  Management should be solely focused on running the business and delivering. Small R&D acquisitions are okay but nothing big".  Deliver what you promised early and the credibility earned will carry you a long way down the road.

7.       Overwhelm or underwhelm with metrics.  Investors need to be able to track a young public company's progress and really understand the mechanics of the model.  That means they need to follow at least some of the key indicators that you watch; those that don't appear on any formal financial statement.   Too little info equals too much risk.  However, here's where it gets tricky.  It's also possible to share too much.  Companies that release pages of data points end up wasting investors' time, as the chaff/wheat balance is out of whack.  

Smart companies put significant effort into determining the right balance for sharing information that will be genuinely helpful to investors but not terribly useful for competitors.  Investors will always clamor for more - or at least the same info that the competition shares, but companies should define their own playing field rather than letting competitors do so. The key is to explain why you give the metrics you do AND to be equally clear about why sharing others will not be helpful.

Why? Here's a recent example.  In our conversations, investors singled out PANW as a company hurt by its lack of clarity.  When the company missed street expectations last quarter, investors lacking the right metrics, could not determine the root cause of the problem.  Long-term investors expressed frustration with the company's lack of transparency and that made a bad situation worse.

Portfolio managers generally believe that a company providing fewer metrics than its peer group is less investor friendly, believing that reduced disclosure creates uncertainty and volatility.  They may be right or wrong on this as, when you think about it, missing more target numbers may not actually be better than missing fewer, but hey; it's what they believe.  So, be ready.  Study what peers disclose and if necessary, be ready to explain why you have chosen a more relevant path.

8.       Talk about your valuation:  This one is simple. Management should, in the words of Taylor Swift, never, ever, ever talk about valuation.  Talk about the company's prospects, talk about products, technology and the go to market strategy, talk about great new hires and customer wins, but do not talk about the valuation of your stock. That's sort of like lecturing Coach K on game strategy.  The audience knows exponentially more about this topic then management ever will.  Management should talk about the business and let investors decide if a stock is a good investment

9.     Fail to provide focused and informed IR:  IR really matters. No let us restate that:  if you have good, reliable, informed IR, it can really matter.  Don't take the easy route or under invest in the function internally. Investors tell us that short-term thinking will come back to bite you if [when] the going gets tough as they will seek reassurances from spokespeople they know and trust to be in the loop.  Better plan: get to know your top investors and develop a strong, direct dialogue.  You will learn as much from them as they do from you.  There is no substitute for having a strong, always-in-the-know, dedicated IRO - just ask your investors.

10.   Be ubiquitous:  Most young companies are invited to speak at one or more conferences sponsored by each and every bank on the cover of the IPO prospectus. They are also invited to speak at an endless list of other investor events and constantly encouraged to do non-deal roadshows.  In the early quarters, if the story hasn't changed much from the original pitch, just say "No".  Investors want you focused on delivering results, not speeches.   Even after the first few quarters, trust that generally, less is more. After a few presentations, the returns not only diminish, they approach the horizontal axis.  Attend a couple of key investor events each year to keep your investors informed and as a thank you to analysts for continued coverage.  Supplement that with a couple of non-deal roadshows.   Other than that, meet with investors when you have something new and interesting to say.  They will appreciate that you are using both your and their time well.

We pulled this list together based on many conversations with top investors and seasoned with our own experience.  We've watched many companies learn the hard way. Here's hoping this short cut is helpful.

Oh, and one more thing.  In addition to interviewing the buyside regularly, we run a business.  Therefore this is the part where we remind you that if the unexpected happens, you unavoidably stumble or did not read Parts I and II in time -- feel free to call us for help with Part III “How to get a good company back on track in the public markets.

Monday, June 17, 2013

They're baaack. With the strong stock market performance of the first six months of 2013 (+15%) and with the swing to positive inflows to active equity funds, rather than out, investors have clearly signaled that once again, their interest lies on the denominator side of the risk/reward equation.  Not only are equity investments appealing, but also, even those with higher risk profiles including IPOs are again catching investor's fancy. 

On many fronts, that's good news.  Many are cheering the uptick in IPOs, particularly dramatic in the med/tech space, but don’t be fooled, a robust IPO market conjures up both good and bad memories for investors. 

Never forget that it's one thing to "get a company public", but for those who choose that route, the misnamed IPO "exit" is really just an important milestone on the way to building a sustainable business with the opportunity to thrive in the years ahead.  Unfortunately, as we know too well, the majority of IPOs, even some of the most highly anticipated, race out of the gate only to stumble during the first 18 months on the public company track, often failing to regain their footing fast enough to ever realize a fraction of their potential.

With that in mind, and based on years of working closely with institutional investors, in two parts, we offer our guide for newly public management teams to the top 10 things fledgling public issuers should not do. Ever.

10 Ways to go from super steed to dog chow in record time

1.       MISS YOUR NUMBERS:  Miss the numbers in one of the first 2 quarters after IPO and investors will quickly assume that management is incompetent.  Institutions know that bankers urge conservatism on the early quarterly forecasts.  In fact, the rule is "set expectations that you can not miss". Therefore, if you miss that inch-high hurdle, you either didn't listen or don't have a grip on your business, and it's a very long road to recovery and credibility.  Make sure the model you bless with the street is conservative. They are perfectly happy to have you "beat and raise".  If you miss Q1 or Q2 nothing else much matters from an investor's perspective.

2.       Be naive about the ways of Wall Street;  If you beat the analyst’s model but miss their real expectations, and worse, fail to understand that you missed you will again have credibility issues.  Marin Software is one (of many) poster children for this problem.  The company went public with what appeared to be extremely conservative research analyst forecasts.  Unfortunately, its first quarter results narrowly beat those forecasts and worse, showed growth decelerating more rapidly than the street expected. Oops. Management then compounded the error by meeting with top investors, failing to acknowledge the problem, saying they could not understand the selloff as after all, “We beat the analyst’s models!” Double oops. 

Make no mistake, investors will pummel your stock for any miss, but if management owns up to a rookie mistake, the trip back to credibility will likely be much faster.

How to avoid this pothole? Management should clearly communicate the core metrics by which analysts should measure the business performance and from the start, should maintain a dialog with both the buy and sell side to really understand (not to comment on or change, just to understand) street expectations.  In the event of an unexpected deviation from plan, be ready to fully explain the delta and how you hope to avoid a similar surprise in the future.  Most buyside investors will tell you "there's no such thing as a one quarter problem".  The more rapidly management owns up to the realistic magnitude of the hiccup, the quicker investors will rebuild trust. 

3.       Bash your direct competitors:  In big growth markets there should be plenty of room for multiple players. Bashing competitors sends a message that the market may not be as big or fast growing as investors hoped.  Furthermore, a lower competitor valuation is bound to hit your stock as well, so wish them the best.  Explain to investors factually how you are different, preferably in terms of product performance, architecture, and technology.  Explain why you win when you compete, but do not make your success contingent on beating the other guy.   And one more thing, suing your competitor while they are on their roadshow, particularly about some issue that has been in the markets for months, makes your team look scared, wasteful and just a little pathetic.  It also generally makes the buy side laugh as they have seen that movie before.  Tread lightly on your competitors.

4.       Casually dismiss the behemoths:  Pooh-poohing the ability of those big, well-funded technology companies to respond nimbly and competitively, is never a good story.  At least from our observations, it also generally isn't a good business practice, but that's a different column.   Investors like management teams that are wary, respectful and paranoid.  Acknowledge investors' fears that competitors are big and well-funded and cannot be ignored.  Then tell the buyside what you are doing to maintain your lead, how you have built your financial model to leave room to respond if need be and how paranoia drives you.

5.       Sell too fast:  Sorry folks, active management should not sell stock before reporting two clean quarters.  While this is always true, it is even more distressing to the buyside when individuals who sold in or just before the IPO, hit the cashout button again at first opportunity.  Investors identify management selling in an early lock-up release as a major red flag that can trigger institutional selling or give investors pause about building a bigger position or making a long term commitment.  Public investors prefer management 10b-5 plans as a means of monetization.  That said, sometimes individual management members have been patient or are concerns about diversification.  If an individual hasn't sold recently he or she can sell early (again much better if after two strong and clean quarters) without freaking out investors. The key is to sell 10% or less of vested holdings in the early going.

There you have it; part 1 of our thoughts on errors a newly public company should never make, based on conversations with the buyside.  But wait, there's more... part 2 coming soon.

Monday, May 13, 2013

Straight from the Buy Side - Part 1

Sometimes, its good to go straight to the source.....

With the addition of Leslie Pfrang the enormously talented Leslie Pfrang to open the NY office and head up Class V East, over the past few months, we have been meeting with investors and private company management teams both to discuss our expanded products and services and to listen to their thoughts and concerns about the IPO market in 2013.

What we learned should keep this blog going for  - well, at the rate of recent posts - decades.  Hopefully, we will shrink that down to months.

In future posts, we'll share investors' quotes about bookrunner structures, share allocations, preferred lock-up release strategies and how to recover if something runs amuck during the first year as a public company.  For the first "reveal"of what investors are thinking, we're focused on what, if anything, from the syndicate side has any impact on the decisions by those actually making the buy or pass decision on IPOs.  

Perhaps because it was the question that received the most consistent answer from the country's largest IPO buyers,  we're starting with these investors' almost universal belief that in IPOs, the smaller, full-service or boutique banks are under-compensated relative to value provided.  The comments that follow may be our writing, but they are wholly reflective, and in several cases verbatim quotes, from the country's biggest long-only buyers of IPOs.   We addressed our questions specifically to those firms and portfolio mangers that investment bankers call out when building "ideal ownership" target lists for new issues.

By way of background for those who haven't been through the process, when picking bankers "for the cover" of an IPO, the goal is to build a syndicate of banking teams with different skill sets, serving different investor market segments, hoping that when the time comes for the roadshow, issuers can maximize the number and variety of accounts that will hear the story.  That's the theory.  In reality what happens, particularly as the market has come back from the adventure that was the 2008/2009 debacle, is that issuers will choose as bookrunners several big banks that look very much alike in terms of skills and client focus.  Once those two or more big guys have been promised the majority of the total deal fees, the issuer-to-be will parse out what remains to the smaller banking organizations. 

Issuers are acting pragmatically when they choose this structure.  With compressed bonus structures, there is a great deal of movement by bankers and analysts between firms and therefore, many issuers wisely want to have a big cheese and an "insurance big cheese" firm to work actively on the deal, just in case a banker or the key analyst opts out in the middle of the process.  Furthermore, as no one firm has anything close to a monopoly on good ideas, having more smart minds fully engaged in the process improves the output.  The problem is that by the time two or more big banks have been enticed into the deal, the funds left to compensate the rest of the syndicate are sparse.

During the actual IPO process, at least for "hot" companies, this isn't much of a problem. The simple truth is that for the sought-after companies, those offering a compelling investment thesis, a solid financial plan as well as a credible and skilled management team, most any bank with a balance sheet can place an IPO.  For those that are more complicated or speculative, or for those where something goes wrong after trading begins, the importance of a fully committed syndicate, including several high-quality, engaged co-managers, grows rapidly as investors are likely to seek a cross-section of opinions.

However, once the IPO is in the rearview mirror, the image blurs.  Analysts at the large "bulge bracket" banks, are compelled to spend the bulk of their time and effort following the largest market cap companies. Why? Because coverage of large cap stocks drives a research analyst's Institutional Investor (or II) ranking.  Bankers feature these rankings when pitching new IPO business, to demonstrate the superiority of their research team.  Perhaps even more importantly from an analyst's perspective, research directors use this ranking to determine compensation and allocate the bonus pool.   Perversely, according the investors with whom we spoke, high-ranking in II correlates negatively with strength in on-going coverage of smaller market cap, recent IPOs.  This means that if you, the newly issued IPO, have a market cap much below $2.0 billion or a float much below $.75 - $1.0 billion, you just aren't all that important to those analysts.  You are the talented singer at the Bluebird Cafe and their careers are made supporting the acts at the Grand Olde Opry.

However, the smaller firms earn their stripes by discovering and/or promoting those names everyone doesn't already know. As talented as some of the analysts at these firms are, they are unlikely to have an edge on Google or Apple.  However, they do have the flexibility to spend more time on the "up and comers".  It is for that work that the buyside will pay them.  Long after the IPO fireworks have faded, these are the analysts that are more likely to stay with your company, promoting your story when appropriate - if for no other reason than that they have to do so to  differentiate and stay relevant.

But don't take our word for it.  Here is the specific question we asked the major IPO buyers, followed by the verbatim answers from the investors (in no particular order).

Q. On a scale of 1 to 10 how important are some of the smaller (non bulge bracket) investment banks to the health of the technology IPO and on-going research process.

Investor 1. Boutiques add all the value for companies < $ 3 bln. They do all the real research and can give a more balanced view. I think economics should be paid 60 bulge/40 boutiques on the IPO, maybe more to boutiques on the follow on. Bookrunners on the top line get the quality deals because of who they are. The four guys on the bottom line are what make the stock work over time.


Investor 2: Co-managers do all the ongoing research, they are not all busy with II like the bulge bracket.  II focus for bulge bracket firms means they have to spend most of their time on large cap names, pushing the small cap stocks off to their juniors. Bulge will do non-deal roadshow and call management. Boutiques will do real proprietary research and have a differentiated view. We think 25 to 35% should go to the boutiques on IPO and more on follow on.


Investor 3Boutiques are very important to my decision to invest. Economics for boutiques should be much higher than currently, perhaps 30 to 35%.

These are NOT culled responses from a group of diverse answers, and in case anyone is suspect, note the names on the cover have no impact on the work Class V does.  The truth is that 90% of the companies in our survey answered the questions similarly to those quoted above.  Institutional investors definitely value the big banks but also clearly rely on the aftermarket research provided by the relatively smaller firms.  Quite to the contrary of those bemoaning the demise of the famous Four Horsemen (Alex Brown, H&Q, Montgomery Securities and Robertson Stephens), an entire stampede of somewhat smaller full service, regional and boutique firms are very much alive.  However, it is up to management teams and the boards of companies headed down the IPO track, those thinking beyond the bell-ringing ceremony and on to the quarters and years that follow, to make sure those non-bulge bracket organizations are able to fund the costs of on-going proprietary research. The health of the IPO market depends on it.

Next up: - the buyside's thoughts on the age old - How many bookrunners? question.