April 8, 1996

People have been tut-tutting about the wacky market
for Internet-related initial public stock offerings
ever since Netscape Communications Corp.’s IPO in August
took the start-up company from nothing to a $2.2 billion
valuation overnight.

Since Netscape had no revenues and was then giving away
its product, it was (and still is) what is known as a
“concept buy” — a risky investment with potential for
high returns in a new or undeveloped market.

Equally conceptual was last week’s IPO for the Internet
search-engine company Lycos Inc., whose shares soared 37
percent — and its market valuation to nearly $300
million — by the end of its first day of trading.

But for all the talk of the potential risks to
investors, not enough is being said about the long-term
risks that IPOs may pose to companies that go public too
early. What happens when quarterly financial reports and
being nice to analysts and investors becomes a higher
priority than sales and customers?

For a possible glimpse into the future, look back at
General Magic Inc., the start-up that is probably the
archetypal concept buy in high technology.

From its founding in 1990, General Magic popularized the
concept of “agents” — chunks of software code that hunt
down information over computer networks at the bidding
of their owners. It also designed a “personal
communicator” device for mobile executives.

Though its products were still mostly prototypes,
General Magic offered its stock to the public at $14 a
share in February 1995, in part so that its original
financial backers, including companies like Sony and
AT&T, might see some cash back from their
multimillion-dollar investments.

The shares surged to $32 the first day — but have never
seen such heights since. On Thursday shares traded at an
all-time low of $4, before edging up to close the
four-day trading week at $4.50. Some analysts were
questioning whether the company would survive.

Howard Stevenson, a professor at the Harvard Business
School who specializes in entrepreneurship, said the
desire to provide liquidity for entrepreneurs (or their
investors) is always the first reason that such
companies as General Magic cite for going public early.

“But it ain’t real,” Stevenson said. “If you start to
sell your stock before the company is established, it’s
a signal to everyone that you don’t believe in it.”

As for the second big myth — that going public provides
a source of capital: “Maybe,” Stevenson said, “but only
if the stock goes up.” A third and often-cited rationale
is employee motivation — which, again, is only a
benefit if the stock goes up (and the employees have
been let in on the action).

Yet a stock that’s too hot can be equally problematic,
notes Rob Glaser, chairman of Progressive Networks Inc.,
the Seattle-based maker of Real Audio software for the
World Wide Web. Glaser is dead set against taking his
company public in today’s overheated market.

“Stock is one of the things you offer people early on,
as an opportunity to participate in the upside,” Glaser
said. “Netscape’s valuation went up astronomically, and
now, with a market cap of $6 billion, it’s pretty hard
to say with a straight face, ‘Yes, we’re $6 billion now,
but we’ll be $12 billion a year from now.”‘

If a stock-based incentive can’t increase much in value,
“that can make it difficult to recruit great people,” he
said, although he conceded that the greater visibility
of a public company makes some people want to sign on
anyway.

Despite so many good reasons to hold back, the IPO craze
is making some analysts a bit giddy. They don’t want to
oversell a company’s potential, “but in a hot market
they don’t want to be on the low side of the optimism,”
Stevenson said. “And the companies say, ‘Well, if
Netscape is worth $5 billion, I’m worth at least $1
billion.”‘

Sandy Robertson, a founder of the investment banker
Robertson Stephens & Co. in San Francisco, said that
“when the market is ebullient, like it is now, the
filter is very coarse and a lot of junk gets through.”

He said the firm’s co-founder and chief investment
officer, Paul Stephens, keeps on his desk a stack of
potential IPO prospectuses for companies that he thinks
should not go public. “I wish we could quantify those
stacks,” Robertson said. “We’d call it the Froth Factor
Index.”

When the stacks began piling up fast, he said, it would
indicate that the giddy cycle was about to end.

Mitchell Kapor, the founder in 1982 of one of the
seminal PC software companies, Lotus Development Corp.,
recalls a cycle similar to the current one — a boom of
PC software offerings in 1983.

Based on that history, Kapor predicted: “Over the next
six months or a year or whatever, these stocks are going
to crash. The greedy people who bought in at the IPO
will lose money, the high-tech and Internet stocks will
be perceived as poisonous, it will be impossible to get
the good companies out into the public market for a
couple of years until the market forgets, and it will
again reinforce the image that this ‘technology stuff’
is fly-by-night.”

With that in mind, start-up companies already struggling
with the pressures of surviving in a “concept” market
may want to think twice before embarking on the IPO
path.

“The idea,” Glaser said, “is to build an organization
that’s coherent, where people know how to work together
and know what they want to do — instead of the cultural
equivalent of a shantytown.”

Denise Caruso

Copyright 1996 The New York Times Company