Valley View: Do IPO numbers hint at recession?

Perhaps the most important barometer of health to a venture capitalist is the initial public offering (IPO) market - if you can take companies public (float them on a quality stock exchange), founders and investors can get a return on their investment. After some very healthy IPOs in 2007, we have seen some worrying trends in recent IPOs which are worth dissecting.

First let's recap how an IPO works. Investment bankers approach large financial institutions to see if they like the story of a company they want to take public. If they do, this drives up the share price and size of the offering. This is just like any other market, except that the whole marketing process is compressed into two or three weeks. If the financial guys don't like the story, the public offering is postponed, sometimes forever.

So a key barometer of industry health is the IPO market. Last year there were over 1,300 IPOs worldwide which raised $291bn. However, only a modest portion of these were technology companies, and over 80 IPOs failed to get to market in October and November alone.

One early sign of a downturn is where an IPO happens but where the company sells fewer shares at a lower price than expected. Two recent examples of weak chip IPOs are Intellon and Entropic, both of whom had to lower the share price and the amount they were raising.

The question Silicon Valley chip investors ask is whether this is the beginning of a downturn or not. The particular situation of each company is similar - a concentrated customer base and margin concerns which indicate higher risk. But you can always explain a macro trend one micro trend at a time.

Importantly, both sell chips into consumer products. Is consumer demand weakening? The recent Consumer Electronics Show will give important clues - see my update next time.