In our series of articles Corporate Venturing on the Test Bench, Boris Battistini and Martin Haemmig review and analyse the latest trends
What is the relationship between the internationalisation of new ventures and their initial public offering (IPO) performance? Little is known about the extent to which the presence of foreign activities enhances or diminishes the IPO performance from which, most likely, new ventures fund, at least in part, the geographic expansion.
Recently, an attempt to quantify this relationship of technology start-ups in the US was published in the Journal of Business Research by Joseph LiPuma of Emlyon Business School. The study presents surprising, and somehow counterintuitive, results.
The study asks: does the IPO performance of new ventures with varying levels of international intensity differ from that of solely domestic new ventures? To do so, “it examines this relationship utilising the IPO performance – valuation and timing – of 184 US venture capital-backed, technology-based new ventures and their degree of internationalisation in their IPO year”. The degree of internationalisation of new ventures, observes the author, “reflects its commitment to and dependence on foreign revenues”.
LiPuma continues: “Since firm-specific characteristics relate to IPO performance in established companies, the study here examines whether or not characteristics such as degree of internationalisation relate to IPO performance in young ventures. Regardless of the reason for foreign market entry and subsequent international growth, the fundamental and common logic is that doing so will enhance a company’s performance. Moreover, the study specifically examines US IPO performance at the IPO event, as funds necessary for expensive foreign market intensity or expansion may drive the time to IPO and may be utilised shortly after the event.”
While some past studies simply suggest that internal factors – for example, the top management team – and external factors – most prominently, the quality of host country institutions – affect IPO performance, this research brings to our attention a provocative result. It found a negative relationship between high international intensity and IPO performance.
In particular, “the analyses find that ventures with high levels of international intensity – greater than 25% foreign sales to total sales – have IPO valuations approximately 41% less than similar solely domestic ventures. No significant relationship is apparent at lower levels of international intensity. This outcome suggests that investors’ concerns regarding agency risks and possible expropriation of intellectual property in foreign markets may exceed their perceptions of the gain in resource stocks that ventures accrue from foreign activities over a certain threshold. Investors may more easily quantify the agency costs of high degrees of internationalisation than the future benefits due to resource enhancement or the access to foreign opportunities afforded by intensive international activities.”
Moreover, the research shows that new US ventures that enter foreign markets execute IPOs at a greater age than do domestic new ventures, and this relationship is also associated with the degree of international intensity.
LiPuma observes: “US ventures with low international intensity are significantly older than solely domestic ventures at IPO, as are high-intensity internationalisers. Companies at low degrees of internationalisation may just be beginning their foreign market entry and thus delay their IPO due to resource constraints – for example, management attention – or until they have international success to allay investor concerns. Alternately, such ventures may have grown well in their (US) domestic market, but with evidence of potential in foreign markets via low levels of foreign opportunities, seek public funds to support strategies of geographic diversification.”
US ventures with high international intensity are negatively associated with time to IPO – they execute their IPO later – and receive lower IPO valuations. The delayed IPOs of lower value, LiPuma suggests, may reflect the changes in operational costs of increasing from low to moderate to high degrees of internationalisation. The cost of internationalisation increases at moderate levels, as companies must implement organisational and operational changes to serve foreign customers. Such changes may be costly without commensurate revenues, and ventures may delay an IPO until high levels of international business offset these costs.
As observed by the author of the study, one central message is that “investors apparently consciously provide funds to internationalised new ventures with the expectation that such funding will enhance investor returns. Such funding may be a case of venture capitalist (VC) overconfidence. These ventures may provide higher returns post-IPO – if they are creating real options via foreign market entry that the IPO market is not correctly valuing. If VCs are not cashing in immediately, they may hope to leverage those options in the future.”
What about non-US ventures? Many countries in other geographies are rather small compared with the US. The only solution for them is to go international, or global, since their domestic market is marginal relative to the required investment for building the company and its technology. Therefore, many European, Israeli and Asian tech start-ups have to think and act global from day one – born global. This is also the case for highly specialised technology ventures, since no or only a small domestic market may exist.
Technology ventures in all other countries receive investment amounts significantly lower than in the US – two to four times – to reach the same milestones, and their exit – IPO and merger and acquisition (M&A) – valuation is a mirror image of it. However, if a European venture receives investments only from Europe and exits directly in the US, then the returns – exit multiples – are significantly higher than their US equivalent. This may be more likely in the case of M&A. However, in the case of an IPO in the US, these ventures normally receive a co-investment for their US expansion from a US VC, which may be substantial. Such ventures will grow significantly larger in the US market, which will be reflected in their exit valuation. The exit multiple is more likely to be comparable to their US equivalent. However, the lower capital infusion in Europe will not be reflected as much, since a significant US VC financing will dilute the multiple arbitrage.
If, for example, the main market tends to be the US, foreign ventures with small domestic markets should try to move as early as possible for commercialisation in the US and ideally test the product and market fit for their solution there. There is also a good likelihood that a corporate investor could become a great catalyst to identify not only the US market opportunity but other potential investors.
Furthermore, there are many more VC firms these days with additional growth funds, from young ventures could finance the entire US, or even a global, expansion and keep the venture for an extra two to three years, to scale it significantly and reap the benefit of expansion, instead of exiting early at much smaller scale.
Remarks on the research results
The US research sample is based on 186 US VC-backed tech ventures that went public from 1997 to 2003, hence before and after the dot.com bubble burst, with a total of 826 IPOs during that time (90% from 1997 to 2000). In addition, the time from initial VC investment to IPO was extremely short in contrast to any other economic cycle in the venture capital industry. The period was characterised by an exuberance of investment hype both by VCs and corporate venturers with over $100bn in equity financing in 2000, while investments and exits fell off the cliff in 2001 once the dot.com bubble had burst. Finally, the longer holding period from initial VC investment to IPO have significantly increased revenues with sustainable profitability, which has become the norm in most IPO exits nowadays.
References
LiPuma J (2012) Internationalisation and the IPO performance of new ventures. Journal of Business Research 65(7): 914-21
Boris Battistini is a senior research fellow at ETH Zurich and a project leader of the Corporate Venturing Research Initiative with Bain & Co (e-mail: bbattistini@ethz.ch)
Martin Haemmig is an adjunct professor at Cetim at UniBW Munich and Leiden University (email: martinhaemmig@cetim.org)