Tuesday, August 9, 2011

Venture Capital bitten by Global meltdown

We should really ask ourselves if there should be alternative markets to help venture capital funds exit their deals. Indeed, it takes 5 to 7 years to go from project to company, and another 2 to 3 years to make that company reach critical mass to go public. It's a long gestation period.

Simultaneously, venture IRRs from the last decade, since the bubble burst of 2000, have suffered greatly for the lack of IPOs. Sure you can make breakeven returns as a venture capitalist when you sell your portfolio companies to larger companies, but M&As never command consistent big multiples. Because when M&A is the only route, that means the IPO window is closed and it is a buyers' market for the larger companies fishing in startup territory.

When the IPO window opened significantly in the last 2 quarters, a slew of tech companies rushed to file; more than a 140 at last count. And this crop is a good crop. Good growth run rates, existing revenues, existing cash flow, visible runway to profitability, and overall excellent metrics. Nothing in common with the last tech IPO window of 1999-2000.

But with the current global meltdown in markets, it seems that this IPO window might be closing rapidly. Over $5 billion worth of IPOs have been cancelled, or at least put on hold, over the past two weeks.

"This is another blow to venture capital" says Rachid Sefrioui, Managing Director at Finaventures, a Los Angeles based venture firm, "we've been waiting for 10 years to taste public stocks again and give hope to all startups, and now this comes from left field."

The U.S. debt situation has been known to all fund managers for a while now, but the S&P downgrade radar-clocked the investment community. "You know you're speeding down the freeway, but it doesn't hit you until those cop sirens light up in your rear-view mirror." Continues Rachid Sefrioui "how do you solve the revenue part of the government budget if the first hit is the number one industry in job creation?" 

Indeed that is what U.S. leaders have to figure out. Cutting taxes is a nice stimulus, but you have to wait long enough for venture companies to finish gestation and go public, and as we know 92% of job growth in venture-backed companies comes post-IPO.