They're back.
After all but abandoning Silicon Valley in the wake of the first dotcom implosion, Wall Street bankers have returned to the tech Mecca en masse, in search of -- what else? -- riches to be made taking startups public.
But the moneymen of the bulge-bracket -- Bank of America Merrill Lynch (BAC), Citigroup (C), Goldman Sachs (GS), JP Morgan (JPM), Morgan Stanley (MS) and UBS (UBS)—can expect a chilly reception. Some of the ill will feels a bit like something out of a John Hughes movie: The studious kids simply don't like the richies making money off their inventions. And there are questions about whether banks are underpricing the public offering deals they covet, allowing them to sell stock to institutional clients cheaply—at the expense of startup insiders and founders. "Silicon Valley has always had a love-hate relationship with Wall Street," says Christopher Dixon, the former global strategist for media research at UBS and current vice-chairman of Minyanville Media.
Dixon and other longtime observers of the scene say there's now growing resentment over the banks' practice of double dipping: taking pre-IPO positions in promising startups then collecting underwriting and other client fees when those companies go public.
Exhibit A: Goldman Sachs' recent deal with Facebook. In January, Goldman invested $450 million in the social networking site and presented its non-U.S.-based high net worth clients with an opportunity to invest in Facebook as part of an effort to raise an additional $1.5 billion on the company's behalf. As a result, Goldman would seem to have an inside track to underwriting Facebook's public offering.
The problem with these kinds of multilayered relationships, some say, is that the bank always wins, even if the startup and individual investors lose. By being both an investor and an underwriter, the banks are often in a position to dictate when a company should do a stock offering -- often before they have the financial strength to be traded publicly -- collecting fees and seeing big returns without putting much of the banks' own money at risk.
"When the bubble bursts it is their clients who will get harmed because the money at risk is largely investor money," says Ken Marlin, who served as the CEO of numerous tech companies before founding his own advisory shop serving the middle market tech industry.
Thus far the big winners in the underwriting game appear to be JP Morgan and Morgan Stanley, which served as lead underwriters for LinkedIn's May IPO and Pandora's IPO in mid-June, with Morgan Stanley looking collect $7 to $10 million in fees from the LinkedIn IPO alone. (JP Morgan was an underwriter, along with Goldman Sachs, of Zipcar's April IPO.)
On the day of their initial offerings shares of ZipCar (ZIP), LinkedIn (LNKD) and Pandora (P) all soared past their offer prices, though Pandora has settled a few bucks below its $16 initial price.
Why the mismatch between the offering prices and the market values? Many Silicon Valley venture capitalists and financiers say that's because bankers are carpetbaggers who don't spend enough time in the Valley and with the companies they represent to accurately assess their potential.
Unfortunately for the upstarts, they can't bypass the big banks the way they might have in the days of Hambrecht & Quist and other boutique banks. The sums some new companies are raising -- $5 billion to $10 billion -- are so great that only a Goldman, Morgan Stanely or JP Morgan has the wherewithal to do it. Moreover, as Dixon notes, "it isn't just about getting into the public markets; it's also about being able to support the company in the aftermarket, and that puts these big tech companies right in the hands of the large brokerage firms."
But hot companies like Facebook do have leverage, at least when it comes to the fees they pay their underwriters: Sources predict Facebook will try to negotiate the standard 7% fee, which has already inched downward since Google's (GOOG) IPO, down to 5% or less. If one bank doesn't like it, there's sure to be a rival that would be willing to take a haircut to be part of what's sure to be a huge offering. (CNBC recently reported that Facebook is planning an IPO that would value the company at $100 billion.) Says Mark Patricof, managing partner at boutique bank MESA: "Technology companies that are in a privileged position through performance or brand acceptance have significantly more leverage than banks in the marketplace. Money is commoditized; the banks are just one source of capital for them."
