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Update: VCs Reap What They Sow

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There’s grim data out today from two sources that track venture capital exits, both of whom noted that not a single venture-backed company went public in the second quarter of 2008. This is a grim news indeed, but not surprising.

Update: Dow Jones issued a revised version of this release with new median deal value data. Those changes are reflected below.

What’s worse is that M&A activity is down by almost half, median deal prices have dropped to $21.3 million in the latest three-month period from $22 million in the second quarter of 2007 and the median age of companies being sold is 6.9 years, but the median value of those deals is on the rise with prices jumping from $55.8 million in the second quarter of 2007 to to $87.6 million for the latest three-month period according to Dow Jones data. In other words, large tech firms aren’t just shopping for startups, they’re bargain hunting are shopping less but willing to pay more. So even without Without the a credible threat of an IPO, and with venture firms eager for an exit, it’s no wonder that deal prices are going down strategic buyers are willing to pay up.

Fewer deals, older deals and lower prices wreak havoc on a venture firm’s internal rate of return, which they use to show pension fund and other institutional investors how successful they are. The goal is not just to make a huge return, but to do it fairly quickly. So the crumbling exit environment will likely hurt marginal firms, ones that don’t have general partners who can use their influence and position to push deals through.

But this is the exit side of the equation, and it’s just as important to look at what was happening a few years ago when the firms who have since made it to an exit were funded. Given that the median age of firms exiting today is almost 7 years, a good comparison in terms of funding seed and startup companies would be from mid-to-late 2001: Venture firms put in $766 million into 264 seed-stage and startup companies that year, or only 6 percent of the total number of deals (looking at dollars in this case would skew the data), according to the PricewaterhouseCoopers MoneyTree report.

So while I do believe that it’s harder right now for firms to go public, the fact that early-stage funding dove off a cliff after the dot-com bubble and didn’t start a sustained rise until the middle of 2005 means that fewer IPOs may not lead to huge venture crisis. There is a rising backlog of later-stage companies waiting to go public or get acquired, but in a cyclical business it’s important to look at the entire cycle. I don’t think we should panic just yet.

7 Responses to “Update: VCs Reap What They Sow”

  1. bill gates

    “Tech” is officially dead. What killed it? Well reason suggests high energy and resource costs will continue to suck money from the consumer economy. Inane patent and intellectual property laws which only serve to reward establishment players over innovative startups.
    And, lastly the secular bear market in stocks which will not end for another 20 years.
    I left Microsoft because the title of “worlds richest man” will be like a bull’s eye in the eyes of the hordes of resentful poor. The future of the economy will be in local farming, mining, and perhaps passenger rail. Look up my friend James Howard Kunstler for more…

  2. Great insight. Based on this logic – which makes complete sesne -we should see similar low numbers for the next couple of years.

    However, I wonder if the numbers will tick up after that. Although VC funding has certainly increased after the 2000-2002 drought, it seems like the exit strategy for most technology firms these days is to get bought out. Rarely do you hear the “IPO” goal any more.

  3. Well, if the VC’s are drying their powder, maybe they should invest in another round of YASN’s and Facebook applications, or maybe another video sharing, how-to, or uploading site!

    How about a social network for your apartment building! Or a Socnet for elderlywith out computers. Or…….another recommendation engine. Or a mobile social network to…wait for it – help you find your friends at the bar.

    Above all, do not invest in mobile data ventures where the end-users have agreed to pay 20-30 / mo. for subscription dispatch services for independent automotive services trades. No…..that would make money.

    Likewise, don’t invest in technical vertical and specialty markets. They pay cash up front, and high recurring subscription fees. That would make money. Don’t invest in that, either.