No venture-backed company managed to go public in the second quarter, and the National Venture Capital Association warned Tuesday that startup companies are facing a “capital markets crisis.”
The initial public offering drought of 0-for-April, May, June is the first in 30 years, according to the NVCA.
Citing a tougher regulatory environment as well as a weak stock market, the NVCA said startup firm executives are pessimistic about even attempting stock offerings.
“Venture-backed companies that successfully enter the public markets represent a critical job creation engine for the United States economy, and that engine has completely shut down,” said Mark Heesen, the NVCA’s president, in a statement. “We need to put regulators, legislators, presidential candidates, and the private sector on notice that this situation represents a serious problem that will have long reaching economic implications if not addressed. We view this quarter as the ‘the canary in the coal mine’.”
In another report, Dow Jones VentureSource also noted the IPO drought but also reported that merger-and-acquisition activity slowed sharply. IPOs and M&As are the two primary exit routes for investors.
M&A activity in the second quarter plunged to 56 deals worth $4.7 billion, down from 97 deals and $8.8 billion in 2007.
However, in the deals that were made the average value of the venture-backed firm being acquired soared 57 percent to $87.6 million.
“The broader pull-back in the economy is affecting corporate spending and is clearly impacting the number of deals in the M&A market,” said Jessica Canning, the global research director for Dow Jones VentureSource. “Corporations might be out looking for venture-backed companies to acquire but many are either doing so quietly or choosing to hold off on entering into negotiations. The rise in the amount paid for acquisitions demonstrates corporations’ willingness to pay for companies that are important for their growth.”
In a survey, NVCA said virtually all VCs believe the IPO situation is a threat to the “future health of the venture capital and entrepreneurial communities.”
However, Ben Brooks of Southern Capitol Ventures in Raleigh, is among those VCs who don’t see the capital markets problem as being as grave.
“I think crisis is too strong a word for me,” Brooks said. One side effect is beneficial in his view. “There is a bigger emphasis on companies to become profitable more quickly. The good news is that companies are either profitable or on a plan for profitability.”
The startups most affected by the IPO droughts are pharmaceutical firms, he added.
“The crisis is larger for life science firms that have no income and the only way to get liquidity is with an IPO,” he explained.
Brooks acknowledged that regulatory costs, such as stipulations required by Sarbanes-Oxley financial guidelines, have increased and therefore made an IPO process more difficulty. He also noted that merger-and-acquisition activity has slowed, but he attributed the lack of deals to the fact “the stock market is down. If you’re merging on paper, your companies are worth one-third less than they were a year ago. But I believe M&A will bounce back when the markets recover.”
The NVCA, however, said in a statement that the group “will be calling on legislators, regulators, and private sector participants of the capital markets ecosystem to begin a dialogue on the necessary steps to address this situation.”
Sarbanes-Oxley, which was implemented following the dot cot meltdown and 2001 Wall Street debacle, has long been a target of criticism by the NVCA. The group noted that the average age of firms going public in 2007 was 8.6 years – a 27-year high.
And the IPO pipeline is far from full. Some 42 firms have filed for IPOs as of June 30 compared to 72 in the third quarter of 2007.
So far in 2008 five VC-backed firms have gone public compared to 47 for the first six months of 2007.
Even if IPOs were being executed, most VCs are less inclined to back stock offerings, the NVCA said, In a survey:
• 81 percent of VCs said they didn’t expect IPO opportunities to improve this year
• 66 percent believe VC firms are less likely to seek an IPO now than three years ago
• 57 percent of VCs see Sarbanes-Oxley regulation as the third biggest factor in the IPO slowdown.
• Top reasons for lack of IPO action were skittish investors (77 percent) and credit crunch/credit crisis (64 percent)
Dixon Doll, the NVCA chairman and a VC based in California, said the IPO drought is due to more than the overall economy.
“While we clearly recognize that the IPO drought is being driven largely by a weak economy, there are other systemic factors that are making the IPO exit less attractive for high quality venture-backed companies,” he said in a statement. “Our government and the private sector should be doing all that it can to encourage these innovative, high quality companies to enter the public markets and grow from there. The acquisition will always be an attractive and viable exit path for venture-backed companies, but the public offerings create visible, long term economic growth. Imagine the implications if Genentech, Google, or Intel decided to forgo a public offering and become acquired because the public market option was unappealing. The ‘next Genentech or Google’ may be making that decision right now. The best choice for that company should also be the best choice for our capital markets system and our economy.”
