Floundering public markets, skittish investors and the expensive process of going public have stopped venture firms from listing portfolio companies – a turn of events with ripple effects throughout the GP and LP communities.
There were zero venture capital-backed initial public offerings in the US in the second quarter of 2008 for the first time since 1978, following a quarter in which there were only five venture-backed IPOs.
Those statistics equal a “capital markets crisis for the start-up community”, according to the National Venture Capital Association.
We're calling it a crisis because when you have 120 quarters go by and you've always had an IPO and suddenly you don't, that's a concern
“We’re calling it a crisis because when you have 120 quarters go by and you’ve always had an IPO and suddenly you don’t, that’s a concern,” NVCA president Mark Heesen told PEO.
The slowdown in IPO activity will endure at least another six months, said Heesen. An exit poll conducted by the NVCA with Thomson Reuters showed 81 percent of venture capitalists do not see the IPO window re-opening in 2008.
“There’s certainly a lot of negativity in the markets in general,” said CMEA Ventures managing director James Watson. “I think the appetite for the buyers of IPO shares right now, as well every other share in the market is just not there.”
There has also been “squeamishness” on the M&A side, said Heesen. M&A activity was down 28 percent in the first half of 2008 as compared to the same period last year, according to the NVCA.
The median age of a venture-backed company from founding date to IPO hit a 27-year high in 2007 at 8.6 years. Heesen expressed concern that firms are being compelled to hold companies longer and venture capitalists do not have time to invest in new companies as they focus on current portfolios.
The best alternative [to an IPO] is to keep building your business
The expense of going public makes companies especially wary of public offerings in a weak economy. “The best alternative [to an IPO] is to keep building your business, make it profitable, create a great cash flow and wait for a better market and I think that’s a lot of what’s going on,” said Watson.
Longer holding periods have led some investors to seek liquidity in the burgeoning venture secondary markets.
“In the first quarter of 2008 alone, we witnessed nearly a three-fold increase in our liquidity-centric investment activity,” said Samuel Schwerin, managing partner of Millennium Technology Ventures, a Blackstone Group spin-out that specialises in complex venture secondary transactions.
Initially driven by individual shareholders and executives of venture-backed companies, Millennium’s liquidity-centric deal flow has in the past several months reflected an increase in institutional investors considering alternatives, “from wholesale liquidity via SPAC transactions to secondary liquidity from firms like Millennium”. The latest NVCA data only reinforces this need, Schwerin said.
“The confluence of an economic downturn, shuttering of capital markets to anything involving ‘risk’ and falling technology valuations has left the traditional venture investor with a dearth of options for liquidity today,” Schwerin said. “As more and more companies witness the evaporation of traditional sources of liquidity, we are seeing a marked increase in the acceptance by boards and management of this alternative source of liquidity for their shareholders.”
Not all market participants concur, however.
CMEA’s Watson said he hasn’t seen an increase in secondary market activity.
“If a company is not doing so well then nobody wants it, and if it is doing well and you’re just waiting for the market to improve, then nobody wants to sell,” said Watson.
Heesan, on the other hand, agreed that secondary activity is growing, but says he doesn’t “see it as an answer to our problems”.