Funding bonanza has come to an end

The technology sell-off has seen massive shifts in company fortunes, leaving some clinging to shares worth only a fraction of their previous value.

Ian Mitchell

City briefing

The technology sell-off has seen massive shifts in company fortunes, leaving some clinging to shares worth only a fraction of their previous value.

Difficult as it may be for these companies to accept, having experienced as much as a 90% fall in their market capitalisation, they could be considered lucky.

Its never been easy to put a valuation on companies coming to the market which will make losses for a number of years and whose technology products and services, while promising, do not have a track record of sales growth.

It looks like the end of March this year, when Nasdaq and Techmark hit their peaks, was the most optimistic view of the likely earnings from such firms; let's hope we will look back in a year or so and say that the end of November was the most pessimistic view.

One of the biggest disappointments with regard to falling share prices has to be that good fledgling UK technology companies are facing a rather more precarious future as a result.

It has now reached the stage where fund managers are hesitant to back technology IPOs because they are worried their investment will fall heavily when the shares begin trading.

This is the exact opposite of the case earlier in the year when almost any new issue, no matter how flaky the idea, was guaranteed a substantial premium on its first day of trading. It's funny how, until recently, private investors were clamouring to be allowed to invest in IPOs - now we barely hear a word from them on the subject.

Meanwhile, venture capitalists are reluctant to provide more funds as this would further increase their exposure. So we have a situation where strong product offerings are being held back because the companies behind them cannot access funds to continue development.

Furthermore, companies that came to the market earlier in the year and raised cash at the valuations then have far greater resources available to them than those coming to the table now. So where do these fledgling companies turn now?

Earlier in the year a new breed of company, the technology incubator, was born to help young IT companies develop their offering and raise finance to support their plans, taking a stake alongside other investors.

More than 35 incubators were floated and raised a total £420m on the Alternative Investment Market (AIM)between October 1999 and March 2000. In March, these incubators accounted for 10% of the value of all AIM stocks, but now account for just 4%, thereby underperforming even in a falling market (see graph). In the beginning, these incubators had enormous valuations - it was not unusual to see an incubator consisting of a few people with a contacts book and, say, £5m cash in the bank being valued at £50m.

Now some have swung so far as to have the £5m cash in the bank but a market capitalisation of £3m. There remains a great deal of cash in these incubators, and we will begin to see which of them have the steady nerve required to continue investing in technology. After all, the companies have not changed, but the valuations have plummeted - so if they believed the story before, now is a good time to invest.

Ian Mitchell is an IT analyst with stockbroker Beeson Gregory. His opinions should not be construed as investment advice.

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