NetSuite's IPO: How Sweet It Is

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12, 74 venture-backed companies went public, compared with 57 in 2006, according to data from the National Venture Capital Assn. and Thomson Financial (TOC). In August, software company VMware (VMW) held a blockbuster IPO that raised nearly $1 billion (BusinessWeek.com. 8/14/07).

Tangled Connections

But NetSuite's IPO isn't without risks. The company, founded in 1998, hasn't yet managed to turn a profit. It pared its loss for the first nine months of the year to $20.6 million, compared with $27.6 million in 2006. Revenues grew 63%, to $76.8 million. Selling software through on-demand licenses can be challenging for vendors, since they book less revenue at the beginning of contracts compared with traditional licensing arrangements and need to reckon that many of their small customers will go out of business each year. Deborah Farrington, a general partner at StarVest Partners in New York, which invests in NetSuite, says investors have become more confident buying shares of on-demand software suppliers, but that such companies are "often expensive to build."

NetSuite also faces stiff competition. German software powerhouse SAP (SAP) has begun selling a suite of Web-delivered business applications (BusinessWeek.com, 9/19/07), called Business By Design, for midmarket companies. Microsoft (MSFT) and Oracle (ORCL) also are developing software that can run in that fashion, and Salesforce is eyeing expansion into adjacent markets, which could include NetSuite's.

And then there is the larger-than-life Ellison, standing near the center of the software industry's transition to this new style of sales. He was also an early investor in Salesforce.com, and NetSuite's IPO will further spotlight the company's deep relationship with Ellison. NetSuite plans to use part of its IPO proceeds to pay down an $8 million loan from Ellison's investment firm. Ellison and his family will own two-thirds of the company's shares after the offering.

Happy New Year?

Making matters more complex, Oracle is considered a potential competitor to NetSuite, as well as a possible future acquirer. To reduce concerns about a conflict of interest, Ellison has transferred his 32 million NetSuite shares into a limited liability company "lockbox," which removed his voting rights for the company's directors. But Ellison still has voting power over a sale of the company. "There's a lot of logic" to Oracle one day buying NetSuite, says banker Gebaide. Because of regulations in the Sarbanes-Oxley Act of 2002, Ellison would need to recuse himself from setting the company's purchase or sale price, he says.

There are other ties between the two companies: NetSuite co-founder and Chairman Evan Goldberg spent eight years at Oracle as a high-ranking software engineer, and Nelson was a former marketing executive there. In May, NetSuite bought $5.6 million worth of Oracle software. NetSuite's stock will trade on the New York Stock Exchange (NYX) under the ticker symbol "N." Credit Suisse (CS) and W.R. Hambrecht are underwriting the offering.

If NetSuite's share price is as buoyant as demand for the stock, companies will have fresh evidence that on-demand software has decent prospects. And for tech investors, the IPO could represent a warm welcome to 2008.

Ricadela is a writer for BusinessWeek.com in Silicon Valley.