The 'Crisis' in Venture Capital

There were no venture-backed IPOs in the second quarter, and M&A deals are down. The last time there were no VC-backed IPOs in a quarter was in 1978. The liquidity drought for venture-backed startups is so bleak that the National Venture Capital Association is calling it a “crisis.” Last quarter there were only 5 IPOs that brought in a piddling $283 million. That compares to 43 IPOs during the first half of 2007 that brought in $6.3 billion.

(During the first half of 2008, 42 companies were in registration for an IPO, but they never pulled the trigger—versus 70 for the same period in 2007).

The other exit avenue for startups, getting acquired, is also getting narrower. During the first half of 2008, there were 120 VC-backed M&A deals, compared to 169 during the first half of 2007. Those deals whose amounts were disclosed brought in $6 billion, compared to $8.5 billion in 2007. That is 42 percent less cash for venture investors.

Before you cry yourself a river, consider that if VCs cannot get their money out of startups they may start to put less money into them. Much of this drought, however, seems to be tied to the weakness of the overall economy. It is a crisis that likely will pass. According to a survey of 660 venture capitalists conducted by the NVCA, the “three largest factors to which venture capitalists attribute the current IPO drought are:”

 

—Skittish investors: 77 percent
—Credit crunch/mortgage crisis: 64 percent
—Sarbanes Oxley regulation: 57 percent

 

Here are some of the other responses:

 

—Venture capitalists who do not see the IPO window opening in 2008: 81 percent

—Number of venture capitalists who believe that venture-backed companies are less
likely to want to go public today than they were 3 years ago: Two thirds

—Venture capitalists who characterize the current IPO drought as “not critical” to the future health of the venture capital and entrepreneurial communities: 8 percent

 

Credit crunch aside, it might be time to amend Sarbanes Oxley at least for smaller companies. If the drought continues through 2008, startups that seek VC funding will start to feel the pinch, if they are not already. Yet one more reason to bootstrap your startup until you absolutely need that VC cash.

Original post

Comments

[Lilguy]

You mean disclosure of investment information required by S-O, that is, transparency, inhibits venture capital raising?? If so, I don't want to be any party of venture capital investment.

[punk_ash]

lilguy, very well said.

[notsosiimple]

It's not QUITE that simple. It's not a matter of disclosure, but the amount of administrative hoops that companies must jump through to meet S-O requirements. The number of lawyers, accountants & consultants that a small company must employ simply becomes cost-inhibitive.

The percentage of revenue paid to comply with these rules make it much harder for a company to be profitable... This is why S-O is seen as restrictive.

Oh - and it's not that S-O inhibits Venture Capital RAISING - companies can get the VC money because these expenses are associated with PUBLIC companies. It's the VCs EXITING the investment by IPOing the portfolio company that's hard. A profitable company may not be profitable once you layer on the expense for S-O compliance. (Of course, the increased difficulty in exiting the investment probably means that VCs are more discriminating when it comes to funding early stage companies....)

[User 192674]

Lifesciences ventures are down, do you attribute that to big pharma buys replacing the need for vc efforts

[iThinkBig]

I am in the Consumer Healthcare marketing space including big pharma. Big pharma has plenty of liquidity, they don't need cash. What they no longer have is government support, actually being attacked by Democrats pissed at them because they didn't render to Ceasar in 2006 when they were told to by this retarded, dirty Congress. I could get into market specific problems such as expiring pattents or what not, but a nasty government with Lifesciences as their next tasty treat to tax and exploit is slowing this market WAY down.

Just like energy, the market has factored in the effects of far left socialist government policies for the short and mid-term. Great five year play for companies like Merck and Pfizer that to me are a steal right now. Always love companies with billions in reserves, beaten to nothing stock and can afford to stick around for a few years while replacing non-visionary managers and more reasonable government policy.

[iThinkBig]

Quick comment on raising money for start-ups. Look at the seven year trends for funds like Polaris. During the last few years VC's sat on a lot of money waiting for the next Google. Start-ups and early stage companies have been more then ignored in the last few years. With the liquidity drying up, i-Banks started calling me recently (I own early stage Consumer Healcare, Tech company that remains profitable) asking if I need money. Two years later, my answer is no thanks I will keep my equity. I am going to Toronto to sell the business next week. As the CEO I decided to direcly go on the road with sales to increase revenue and gather critical research then to further attempt sales to the VC or Angel community.

I assume next year will be far easier for a CEO to raise money for a start-up or early stage company. But I have written here on Seeking Alpha and other places that 49% of our GDP is made up of small business which was ignored by the 51% GDP of government and megacorporations for years (actually government and utilities have become ruthless predators of this group, shame on you for taking it out of the little guy!).

The free market does work, the 49% can no longer be ignored without economic perils to the 51% which is now obviously revealing themselves now that Chindia is going to be less profitable for investors in the mid and long term. The 49% of Main St. is dragging down Wall St.

Wow, what an epiphany, America doesn't seem to work as a nation of serfs and nobles. Ingenuity and infrastructure necessary to support the top is propelled by the young and energetic of America, not 60 year old guys dumping money into Chindia or i-Banks creating paper ingenuity. I am surprised it has taken this long for others to post an article about this here. Thank you Erick.

Quote of part of a fiscal/energy plan I sent and was read by the President back in March:

'Have the Treasury invest $150 B into a declaration of Energy Independence (deregulate offshore drilling, ANWR, nuke plants – let’s see if Congress/environmental lobby argues about it, if they do they will lose 08 election, if not then it’s a giant win for America. I like win-win). Heavy investment into biodeisel will offset petroleum imports decreasing demand over time and coal liquification can be utilized for heating oil. Place an additional $50 B into the SBA and provide small business loans through commercial banks that demonstrated fiscal responsibility over the last two years. The SBA guarantees the loans which means the $50 B is only touched if a business fails, rather then bailing out the Central Banks whom are only using the short-term liquidity injection to fix their own balance sheets and further exacerbate the commodities/inflation explosion. Plus, the SBA is great at providing consultative services on writing business plans, connecting angels with small businesses, etc. 49% of the U.S. economy is small business and represents the majority of the Middle Class.'

[Concerned Scientist/Engineer/MBAstudent]

The "big money" fund VC model works well when their are ample opportunities for VC firms to exit their investments. In my opinion there are two many "big money" funds chasing too few deals, which are overinflating valuations and exerting pressure on firms to exit more investments in order to achieve their IRR goals. Large institutional VC funds have become more and more risk averse and funding has continued to move further and further upstream in the development lifecycle. Perhaps this cyclicial economic downtown will force VC firms to rethink their fundraising goals and capital deployment thresholds for investment. One cannot deny the fact there is a current shortage of exit options, but an even greater crisis is the lack of institutional venture capital funding in the seed/pre-seed stages of development. This is why the industry will continue to see more microequity funds spring up in order to help address this funding gap. The alternative exit strategy of merging companies is only stifling innovation. Companies that IPO and exist as standalone entities need to innovate to survive. Simply merging a company upstream into a larger affiliate provides no incentive for companies to innovate. The latter model is flawed and imperils this country's economic development.