silicon valley law group association for corporate growth business growth series 2004 financing...

SILICON VALLEY LAW GROUP

ASSOCIATION FOR CORPORATE GROWTHBUSINESS GROWTH SERIES

2004 FINANCING TRENDSIPO’S, SECONDARY OFFERINGS, PIPES AND

OTHER FINANCING STRATEGIES

JAMES C. CHAPMANSILICON VALLEY LAW GROUP

ROBIN GRAHAMVICE PRESIDENT

NEEDHAM & COMPANY, INC.

CHRISTOPHER W. ALLICKINSTREAM PARTNERS

MARCH 17, 2004


Large and Growing Market Opportunity

Unique and Proprietary Technology

Blue Chip Customer Base

Strong Revenue and Earnings Growth

Management Team with Proven Ability to Execute

Numerous Areas for Future Expansion

What do Investors Look for in Companies Going Public?

Requirements for an IPO

2004 FINANCING TRENDS


What Drives Valuation?

IPOValuation

External Drivers• Broad equity market strength

• Comparable performance

• Quality of IPO performance

• Volume of IPO market

• Inflows into mutual funds

Internal Drivers• Size of market opportunity

• Growth rate

• Profitability

• Future profit streams

• Quality of company

• Quality of management

• Deal structureSupply / Demand

Considerations

Roadshow

Liquidity

Float



•The equity market recovery began in April 2003

•Now showing some signs of being overheated and may require a pullback to get to a more sustainable pace and justifiable valuations.

•Critical Factors for economic recovery:

• Fiscal stimulus, high levels of liquidity, low interest rates, an expanding economy, corporate growth (particularly in earnings) and an improvement in consumer confidence

• …but much of the resulting ebullience has been priced into stock prices

•The equity calendar continues to build strongly.

• Most follow-on offerings will be completed although their successes may vary

• Some IPOs have performed well recently and some have faltered, but all will be held to a demanding standard.

Overview of the Equity Capital Markets



Quarter Ended

March 2003 June 2003 September 2003 December 2003

Index P/E(2) Index P/E(2) Index P/E(2) Index P/E(2)

Dow Jones Industrial Average 7,992.1 19.3x 8,985.4 20.4x 9,275.1 20.9x 10,453.9 22.3x

Nasdaq Composite Index 1,341.1 NM 1,622.8 NM 1,786.9 NM 2,003.4 NM

S&P 500 848.1 29.5x 974.5 31.7x 996.0 27.6x 1,111.9 27.4x

Russell 2000 364.5 NM 448.4 NM 487.7 NM 556.9 NM


Despite major price declines, valuations remain at the upper end of long-term historical ranges.

Current Market Indices(1)

(1) As of March 15, 2004.(2) P/E is based on trailing 12 month earnings

Index Trailing P/E (2)

DJIA 10,102.9 19.9x

Nasdaq Composite Index 1,939.2 NM

S&P 500 1,104.5 22.7x

Russell 2000 567.0 NM



Overview of the Equity Capital MarketsIndexed Market Performance1

(1) As of March 15, 2004.

20

30

40

50

60

70

80

90

100

110

120

130

1/1/01 5/3/01 9/4/01 1/4/02 5/8/02 9/9/02 1/9/03 5/13/03 9/12/03 1/14/04

Ind

exed

Pri

ces

S&P 500 Index (Reported Basis) Dow Jones Industrial Average Russell 2000 NASDAQ 100 Index




-$20

-$15

-$10

-$5

$0

$5

$10

$15

$20

$25

$30

$35

$40

$45

$50

$55Ja

n-0

0

Mar

-00

May

-00

Jul-

00

Sep

-00

Nov

-00

Jan

-01

Mar

-01

May

-01

Jul-

01

Sep

-01

Nov

-01

Jan

-02

Mar

-02

May

-02

Jul-

02

Sep

-02

Nov

-02

Jan

-03

Mar

-03

May

-03

Jul-

03

Sep

-03

Nov

-03

Jan

-04

($ i

n B

illi

on

s)Net Cash Flow Equity Mutual Funds




$0

$5

$10

$15

$20

$25

$30

$35

$40

Ja

n-0

0

Ap

r-0

0

Ju

l-0

0

Oct

-00

Ja

n-0

1

Ap

r-0

1

Ju

l-0

1

Oct

-01

Ja

n-0

2

Ap

r-0

2

Ju

l-0

2

Oct

-02

Ja

n-0

3

Ap

r-0

3

Ju

l-0

3

Oct

-03

Ja

n-0

4

Am

oun

t F

iled

($

in B

illi

ons)

0

50

100

150

200

250

Nu

mb

er o

f D

eals

Total Public Equity Offerings Filed

(1) From January 1, 2000 through March 1, 2004.Source: CommScan EquiDesk




(1) From January 1, 2000 through March 1, 2004.Source: CommScan EquiDesk

Total Public Equity Offerings Priced

$0

$5

$10

$15

$20

$25

$30

Jan

-00

Ap

r-00

Jul-

00

Oct

-00

Jan

-01

Ap

r-01

Jul-

01

Oct

-01

Jan

-02

Ap

r-02

Jul-

02

Oct

-02

Jan

-03

Ap

r-03

Jul-

03

Oct

-03

Jan

-04

Am

ou

nt

Ra

ised

($

in

Bil

lio

ns)

0

50

100

150

200

250

Nu

mb

er o

f D

eals



IPO Volume

Technology offerings dominated the new issue market in 1999 and 2000, then declined significantly in concert with the drop in the technology equity markets. Over the past few years the only areas of strength in the market were in the Financial Services and Real Estate sectors

IPOs priced in 2003 experienced an average 10.9% gain on their first day of trading and have continue to perform well averaging a 33.0% gain since the offering.

As a result of this strong performance the market is becoming more receptive to IPOs from issuers in a broad range of markets including an expected surge of activity in the technology offering market.

Initial Public Offering Volume by Sector ($ in Millions)Initial Public Offering Volume by Sector ($ in Millions)Initial Public Offering Volume by Sector ($ in Millions)Initial Public Offering Volume by Sector ($ in Millions)

* Source: CommScan EquiDesk, excludes closed-end funds.

($’s in millions)

$-

$4,000

$8,000

$12,000

$16,000

$20,000

1999 2000 2001 2002 2003 2004 YTD Backlog

(Vo

lum

e in

mil

lio

ns)

Technology Healthcare Industrial / Machinery Retail Consumable Goods Energy/Utilities Financial Services Real Estate Other

Current1999 2000 2001 2002 2003 2004 YTD Backlog

Technology 36,478 47,139 8,172 2,126 2,767 427 4,594

Healthcare 3,451 7,063 4,446 4,593 593 1,219 1,698

Industrial / Machinery 8,508 646 306 982 2,100 696 762

Retail 4,989 1,223 855 3,779 1,005 17 308

Consumable Goods 2,708 635 8,777 154 8 0 0

Energy/Utilities 512 4,845 3,020 497 267 217 148

Financial Services 9,284 7,137 7,654 10,736 3,402 2,580 2,617

Real Estate 229 0 0 763 2,646 660 1,194

Other 4,194 2,397 4,712 870 1,052 0 362

Total 70,352 71,084 37,942 24,500 13,841 5,815 11,683



IPO BacklogOffering Backlog by # of DealsOffering Backlog by # of DealsOffering Backlog by # of DealsOffering Backlog by # of Deals

* Source: CommScan EquiDesk

Includes all pending initial public offerings

Offering Backlog by $ValueOffering Backlog by $ValueOffering Backlog by $ValueOffering Backlog by $Value

Industrial/ Consumable Energy/ Financial RealTechnology Healthcare Machinery Retail Goods Utilities Services Estate Other Total

# of Deals 20 22 5 5 0 4 18 6 6 86

Dollar Volume ($M) 4,594 1,698 762 308 0 148 2,617 1,194 362 11,683

Technology23%

Healthcare25%

Industrial / Machinery6%

Retail6%

Consumable Goods0%

Energy/Utilities5%

Financial Services21%

Real Estate7%

Other7%

Technology39%

Healthcare15%

Industrial / Machinery7%

Retail3%

Consumable Goods0%

Energy/Utilities1%

Financial Services22%

Real Estate10%

Other3%



Special Bracket FirmsSpecial Bracket Firms

Citigroup (Salomon Smith Barney)CS First BostonGoldman SachsLehman BrothersMerrill LynchMorgan Stanley

Citigroup (Salomon Smith Barney)CS First BostonGoldman SachsLehman BrothersMerrill LynchMorgan Stanley

Regional Retail, Institutional or Emerging Growth FirmsRegional Retail, Institutional or Emerging Growth Firms

A.G. Edwards (St. Louis)Adams Harkness & Hill (Boston)Friedman Billings & Ramsey (Washington D.C.)Harris Nesbitt GerardJanney Montgomery Scott (Philadelphia)Jefferies Group KeyCorp / McDonald & Company (Cleveland)Morgan Keegan (Memphis)Pacific Growth Securities (San Francisco)Raymond James Financial (Tampa)SunTrust Robinson Humphrey (Atlanta)Stephens Inc. (Little Rock)Robert W. Baird (Milwaukee)Wachovia Corporation (Charlotte)Wells Fargo Securities (San Francisco) William Blair (Chicago)

A.G. Edwards (St. Louis)Adams Harkness & Hill (Boston)Friedman Billings & Ramsey (Washington D.C.)Harris Nesbitt GerardJanney Montgomery Scott (Philadelphia)Jefferies Group KeyCorp / McDonald & Company (Cleveland)Morgan Keegan (Memphis)Pacific Growth Securities (San Francisco)Raymond James Financial (Tampa)SunTrust Robinson Humphrey (Atlanta)Stephens Inc. (Little Rock)Robert W. Baird (Milwaukee)Wachovia Corporation (Charlotte)Wells Fargo Securities (San Francisco) William Blair (Chicago)

Emerging Growth Firms NowOwned by Major Commercial BankEmerging Growth Firms NowOwned by Major Commercial Bank

Banc of America Securities (Montgomery)J.P. Morgan (Hambrecht & Quest)CIBC World Markets (CIBC)Deutsche Bank (Alex. Brown & Sons)RBC Capital Markets (Wessels, Arnold)SG Cowen

Banc of America Securities (Montgomery)J.P. Morgan (Hambrecht & Quest)CIBC World Markets (CIBC)Deutsche Bank (Alex. Brown & Sons)RBC Capital Markets (Wessels, Arnold)SG Cowen

Major Bracket Institutional FirmsMajor Bracket Institutional Firms

Bear, Stearns & Co. Inc.UBS Investment BankBear, Stearns & Co. Inc.UBS Investment Bank

Independent National Emerging Growth FirmsIndependent National Emerging Growth Firms

Needham & CompanyThomas Weisel PartnersPiper JaffrayC.E. Unterberg, Towbin

Needham & CompanyThomas Weisel PartnersPiper JaffrayC.E. Unterberg, Towbin

Structure of the Investment Banking Industry



Private Placements Market

Number of private placements (PIPEs, 144a and Reg S) has grown by over 38% annually since 1995

Between 2000-2003, over $210 billion raised through the private market Only $80 billion raised through IPOs over past three years

-

200

400

600

800

1,000

1,200

1,400

1,600

1,800

Tra

nsa

ctio

ns

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004(YTD)

Private Placement Transactions

Reg S

144A

All PIPES

Source: PlacementTracker.com



Transaction Structure

Common stock transactions account for almost half of all private placements, but only 14% of capital raised since 1995

Convertible offerings with fixed conversions dominate structure based on capital raised

Transaction Structure1

Structure Deals % Amount % Common Stock 3,710 46.4% 48,410$ 14.0%Convertible - Fixed 2,265 28.3% 279,931 81.0%Convertible - Floating 1,046 13.1% 7,037 2.0%Structured Equity Line 467 5.8% 1,493 0.4%Common Stock Shelf Sale 231 2.9% 4,744 1.4%Convertible - Reset 153 1.9% 2,541 0.7%Common Stock - Reset 102 1.3% 835 0.2%Convertible - Installment 27 0.3% 425 0.1%

8,001 100.0% 345,415$ 100.0%1All private placements since 1995.Source: PlacementTracker.com



PIPE Market

In early 1990s, PIPEs were primarily opportunistic financings for small and/or distressed, high-growth companies

Often times structured as “death-spiral” or “toxic” transactions

After market collapse, confluence of factors has legitimized PIPE market Dearth of capital for prematurely public, but worthwhile companies

• Mutual fund restrictions on minimum share price, trading volume and market cap precluded ownership

Crossover VCs and private equity firms view select public companies as startups that went public too soon

• Emergence of sub-$100 million small- and micro-cap hedge funds More favorable terms, higher volume and diversification

• In 2003, healthcare and technology/communications issuers accounted for approximately 42% of proceeds raised, down from approximately 65% in 1998



PIPE Trends

PIPE transaction volume has grown by over 29% since 1995 114 PIPEs for proceeds of $1.4 billion in 1995 881 PIPEs for proceeds of $11.6 billion in 2003

114

306

457 440

687

1,251

1,037

767

881

253

-

200

400

600

800

1,000

1,200

1,400

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004(YTD)

-

5

10

15

20

25

30

Nu

mb

er o

f P

IPE

s

Pro

ceeds ($

B)




PIPE Trends Average PIPE proceeds between $10-15 million

12.113.4

11.4

6.8

15.0

19.7

14.2

16.0

13.212.4

$-

$3

$5

$8

$10

$13

$15

$18

$20

$23

$25

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004(YTD)

Average PIPE Proceeds

$M

M




Pricing Trends Recent market recovery has created a more favorable environment for issuers

Common stock at a discount prevalent structure vs. convertible preferred Typical discount has narrowed from 20-25% to 20-15%

• Size of discount dependent on several factors, including:– Liquidity (average daily trading volume)– Enterprise value– Profitability– Transaction size

PIPEs now accepted and even rewarded in the market No longer the “last resort” financing option

Larger private placement candidates six months ago now considering secondary or follow-on offerings

PIPE market expected to remain robust for small-and micro-cap issuers

Recent market recovery has led to generally more favorable terms for issuers.




* A “reverse merger” is a method by which a private company goes public. In a reverse merger, a private company merges with a public shell company thereby “going public” without having to traverse the long and laborious undertaking of an IPO.

* Although the public entity is the legal “surviving” company in a reverse merger, the private company shareholders usually own a vast majority of the public company

shares (usually 90% or more) as a result of the merger.

* The private company normally will change the name of the public corporation (often to its own name).

* The private company’s officers and directors usually become the officers and directors of the public company.

REVERSE MEGERS



EXAMPLES OF SUCCESSFUL REVERSE MERGERS

* Armand Hammer, is generally credited with having invented the “Reverse Merger”. In the 1950s, Hammer invested in a shell company into which he merged Occidental Petroleum.

* In 1970 Ted Turner completed a reverse merger with Rice Broadcasting, which went on to become Turner Broadcasting.

* One of the dot com fallen angels, Rare Medium (RRRR), was a $2 stock in 1998 which found its way over $90 in 2000.

* Acclaim Entertainment (AKLAM) merged into non operating Tele-Communications, Inc. in 1994.

* Waste Management, the market leader in waste disposal.

* Blockbuster Video, the market leader in DVD and video rentals.

* RAE Systems, Inc. a leader in environmental and security sensors.



ADVANTAGES OF GOING PUBLIC BY MEANS OFA REVERSE MERGER

A. The Advantage of “Going Public”

* Active trading market allows shareholders to obtain liquidity.

* Historically, capital has been easier to raise for public companies because the stock has an easily ascertainable market value and can be traded.

* A public corporation may be used for special purposes, such as qualifying as a category two company for overseas offering pursuant to Regulation S.

* Because of the liquidity factor, publicly traded companies generally have higher valuations than private companies of the same characteristics.

* Unlike privately held companies, the existence of a public market for the shares of a company allows it to use its shares as currency to acquire other companies.

* Public companies are better able to stock based compensation such as stock options to attract and retain the best employees.



ADVANTAGES OF GOING PUBLIC BY MEANS OFA REVERSE MERGER

B. The Advantages of “Going Public” through a Reverse Merger

* The costs of a reverse merger transaction are significantly less than the costs required for an IPO. The cost of completing a reverse merger including the acquisition of the public shell ranges from $100,000 to $300,000 with many variables. The cost of an IPO ranges from $200,000to $1,000,000 again with many variables.

* Additionally, reverse mergers can be completed quicker than IPO’s. Generally, reverse mergers can be completed in less than three to four months. An IPO can take up to twelve to eighteen months from inception to completion.

* Another major disadvantage of IPO’s are the current requirements placed on IPO candidates by the investment banking community. Although these requirements vary from underwriter to underwriter, an IPO candidate should have at least $25-$80 million in annual revenue; six quarters of profitability, and a growth rate of 20-40% annually.



DISADVANTAGES OF A REVERSE MERGER

A. The Disadvantages of “Going Public”

* Higher visibility. A public company is essentially under a microscope. There is little confidentiality. All material transactions and contracts become public information.

* The public reporting requirements, need for audited financial statements, compliance with the plethora of SEC rules and regulations and investor relations activities substantially increase the cost of doing business.

* Public companies have long been accused of having a short term business focus. Management often is consumed with the daily price of the companies and manage the business in response.

* The public reporting process and the need to maintain interest in the company takes a tremendous amount of management's time and energy.

* Increased liability. In 2002 there were 259 securities class action lawsuits and in 2003 there were 211. The average settlement in 2001 and 2002 was $16.6 and $24.3 million respectively.



DISADVANTAGES OF A REVERSE MERGER

B. The Disadvantages of “Going Public” Through A Reverse Merger

* Lack of Liquidity. “Public Company Trap”, Orphaned Public Company”, “Twilight Zone”.

* “Pump and Dump” Schemes. Practice by shady promoters who take a stock that has been trading for pennies, merge it into a business that has at least the façade of respectability and a presence in a market that is perceived as hot, hype like hello, sell off as many shares as possible, and exit before the stock price drops.

* “Toxic Convertibles” or “Toxic Debentures”.

* No New Capital.

* Less Due Diligence and Accountability.



CRITICAL SUCCESS FACTORS

* Good Management Team

* Combine the reverse merger with a financing event.

* Develop and implement a strategy for creating a liquid market for the shares.

Elements of this strategy include a financial communications program.

The company must identify the market makers and brokers that trade in the small cap/micro cap market.

Develop relationships with the fund mangers of small cap/micro investment funds and interest them in the company’s story.

* Develop a reputation for integrity.

* Good business plan the ability to execute it with a few resources and infrastructure.

* The company must also hire quality auditing and law firms.

silicon valley law group association for corporate growth business growth series 2004 financing...

Documents

silicon valley law group

equity market recovery

technology equity markets

financing trends ipos

equity calendar

market performance

financing strategies

new issue market