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From Xconomy by Ryan McBride 

We know there’s been a serious decline in exits for venture capitalists and their portfolio companies for the past year or more. Now two separate studies—one from Dow Jones VentureSource and the other done by the National Venture Capital Association (NVCA) and Thomson Reuters—show just how abysmal M&A and IPO activities were in the first three months of 2009.

The two studies differ in methodology, making the deal totals a bit different, yet the general trends are the same. Today Dow Jones reports that just 68 M&A deals involving venture-backed firms took place in the first quarter. The value of those deals totaled $3.2 billion, down almost 65 percent from $9.1 billion in 104 deals counted during the same quarter last year. What’s more, the number of mergers and buyouts so far this year fell to the lowest level since 1999, and the value of those transactions was the lowest quarterly figure since 2003, according to the VentureSource study.

On the IPO front, the liquidity drought persists. Venture-backed firms did not complete a single initial public offering in the first quarter of this year, making it eight straight quarters without a VC-backed company completing an IPO, the VentureSource study says. When will the IPO dry spell end?

The market for initial public offerings is still in a state of shock, with only one U.S. company successfully raising capital to go public during the first quarter, according to a national report.

A study released Tuesday by Greenwich, Conn.-based Renaissance Capital shows that only two companies worldwide managed to complete IPOs during the quarter. The domestic IPO Mead Johnson Nutrition Co., a pediatric nutrition company based in Evansville, Ind., that spun out of Bristol-Myers Squibb (NYSE: BMY).

Still, the report notes that 29 companies have filed up-to-date U.S. prospectuses and that others may be waiting in the wings as tiny, positive signs begin to emerge from the still-frozen global credit markets.

“While issuance will likely remain low in the near future, we believe that several of these prospective IPOs will be able to raise capital and generate significant returns for investors,” the report said.

The Triangle hasn’t seen an initial public offering of one of its companies since early 2007, when boutique lender Triangle Capital Corp. hit the markets.

Since then, a number of companies have filed for IPOs. Three – data storage company Consonus Technologies and drug makers Biolex Technologies and Aldagen Inc. – eventually scrapped their filings. A fourth, Research Triangle Park’s Talecris Biotherapeutics, agreed to be bought by Australia’s CSL Ltd. in a deal that is currently under anti-trust review.

But the fact that Mead Johnson’s shares are trading 15 percent higher than at their issue date in February shows that companies with a more realistic valuation can create good opportunities for investors, according to Renaissance analysts.

The firm expects that the next IPO on the U.S. calendar, Chinese online game developer Changyou.com, offers the potential for strong revenue growth, despite its reliance on a single video game product.

A stream of withdrawals over the past 12 months has whittled the U.S. IPO pipeline to 142 companies, including 84 operating companies and 58 SPACs — shell companies that raise funds and then look for an acquisition.

So far this year, only four companies have filed for new offerings, compared to 67 during the first quarter of 2008.

Only 43 IPOs by U.S. companies made it to market in 2008, raising total proceeds of $43 billion. That compares with 272 IPOs in 2007 that raised $59.7 billion.

From The Latest from VC Ratings 

The good news is that the worst year for initial public offerings in 30 years is over. The bad news is that there may be a repeat in 2009, as candidates drop their registrations as prospects for a successful offering deteriorate. The number of companies in the IPO pipeline fell by 30% in the fourth quarter of 2008, according to data released by accounting firm Ernst & Young LLP.

The quarterly Ernst & Young U.S. IPO Pipeline study reported there were 57 companies registered to go public at the end of 2008. The IPO pipeline is being starved by turmoil in equity markets that has left many venture capital and private equity-backed companies unwilling to test the market. Additional pressure comes from fears that companies that are just ramping up revenues or that have large debt loads won’t be able to survive the recession.

The effects of the closed IPO window are being felt throughout the private capital community, as the one-year all venture private equity performance index, or PEPI, fell into negative territory ( -1.6%) in the third quarter of 2008, down nearly 7% from the previous quarter. Both types of investors are also being confronted with the choice of pouring more money into their struggling portfolio companies or see them collapse in the changing landscape.  

The E&Y study said that 16 companies withdrew or postponed their IPOs in the fourth quarter. Another 14 companies were removed from the report because they had been in registration for more than a year. There were only six IPOs in all of 2008 — the worst performance since 1977 — and 260 acquisitions of VC-backed startups, marking the first time in five years when the annual M&A tally dipped under 300. - George White

See Ernest & Young stats
See Dealscape post on IPO market in 2008
See Dealscape post on PE/VC performance

From The Startup Lawyer by Ryan Roberts

It is bound to happen eventually, right? A venture-backed company will break the drought and find an exit via IPO. Well, OpenTable filed with the SEC and is looking to raise up to $40MM in an initial public offering. If successful, OpenTable will be the first venture-backed IPO in several months.

There were only 6 venture-backed IPOs in 2008 and the common thought is that 2009 won’t do much better. So an early 2009 venture-backed IPO could bode well…but of course registering for an IPO doesn’t always mean the IPO goes through. At least 36 venture-backed companies cancelled their IPO plans in 2008.

As for OpenTable, I remember using its online restaurant reservation system in 2000 while living in San Francisco. Who knew I was an early adopter?

From Get Venture by Mark Davis

An important trend is taking place in the venture marketplace – it is taking longer for VCs to exit their investments.

In 1995 (before the Internet boom), the average software acquisition occurred 48 months after a company was launched. Initial public offerings were made at an average of 56 months into a venture. In 2007, M&A happened on month 65 and IPOs on month 67. That’s a significant change – 35% and 20% later, respectively.

What’s unclear to me is whether or not this trend will reverse over time. If the time to exit continues to lengthen it could have a number of consequences. Some of the potential impacts include:

• Longer LP Commitments: Venture funds are designed in such a way that their limited partners are required to commit capital for about 10 years. However, with an average five and a half years to IPO, there are bound to be companies that don’t exit for up to a decade, meaning that LPs may be required to commit their capital for a longer period.
• Increased Liquidity Premium: LPs agree to lock-up capital in a venture fund for up to 10 years due to the expectation that the risk they taking in having the capital tied up (which may mean they miss future investment opportunities) is compensated by higher returns. If the lock-up period increases, LPs will likely demand a higher return (or they’ll invest their money elsewhere such as with hedge funds or leverage buyout firms).
• Lower Valuations: If VCs across the board need to generate higher returns (and they can’t increase their time to exit) they will likely require greater ownership of their portfolio companies, translating into lower valuations of startups and greater dilution of entrepreneurs.

This scenario is a losing situation for everyone and I am optimistic that the market will evolve back to shorter exit times as the M&A and IPO markets enter future legs of their cycles. However, it’s important to continue to watch these dynamics as they could have industry-wide consequences.

From Get Venture by Mark Davis

The average company exiting through a public offering is more mature than a company that exits through an acquisition, at least since 2000.

There is good reason for this extra maturation. Public investors are often seeking to buy shares in companies that will continue to operate independently long into the future. In contrast, corporate acquirers may buy companies when they are very young before the company has demonstrated its ability to sustain itself. There are a variety of reasons why a company might be bought without demonstrating financial sustainability; a fledgling company might be acquired for its assets (technology, customer, contracts or management) or it may be acquired as a defensive maneuver – to eliminate the opportunity for the company to become a long-term threat.

It could also be argued that Sarbanes-Oxley legislation, which requires additional internal process documentation and oversight by public companies traded on U.S. exchanges, has delayed public offerings. Companies must ensure they will be compliant with Sarbanes-Oxley regulations, and that they can afford to pay the associated costs, before they can issue public stock for the first time.

From the period of 1996 to 2008, the average company that IPO’d was 8 months older than the average company to be acquired. It’s worth noting that this pattern didn’t hold true during the Internet boom. In the period of 1996 to 1999, the average software company making its initial public offering was five months younger than the average company being acquired (according to Dow Jones Venture One data).

The general trend of IPOs taking longer to realize than acquisition also puts pressure on investors to push for larger exit values. VCs are judged by their investors based upon a number of metrics, one of which is call the Internal Rate of Return (IRR). An IRR is an accurate way of measuring the average annual rate of return on invested capital adjusted for the timing of cash flows. A simple relationship that comes from this math is the fact that longer times to exit reduce the effective annual return. Returning 200% of invested dollars in 1 year implies a higher average annual increase in value than returning 200% of invested dollars in 10 years. As a result, the delay in exit time drives VCs to require higher exit values to adjust for the delay. While in theory the increase in value can be justified by the company’s ability to expand its operations and increase revenues over that period, every exit is ultimately a negotiation and this delay drives VCs to target higher exit values.

From Get Venture by Mark Davis

IPO or initial public offering is another of the four types of exits. In an initial public offering, a company first sells a portion of it shares in a public market, such as the NY Stock Exchange or the NASDAQ.

By “going public,” a company sells a portion of its stock to investors that are entitled to freely sell their shares over the specified exchange. Through the exchange, they can sell directly or indirectly to virtually any buyer in the world.

It’s worth noting that not all of the company’s stock is publicly accessible at the IPO. Companies typically sell only a portion of the company to investors through the public exchanges.

What makes IPOs so special is that subsequent public offerings are less risky for the company as they have more information about the stock’s pricing once shares are being freely traded and priced by the market. During the IPO, the company’s investment bankers are tasked with creating a small marketplace and identifying clearing prices for the initial shares. After those shares are sold, the buyers can transact them freely, yielding prices that reflect the valuation applied by more buyers and sellers, creating a price that is truly reflective of the market’s estimate of the company’s value.

VCs, entrepreneurs and others often participate in the public offering, meaning that they include their shares in the group that is sold to the market. This enables VCs to exit at least a part of their investment – shares are converted into cash which can be distributed to their limited partners.

VCs generally like exiting through IPOs. While IPOs present investors with some liquidity risk, as insiders are often subjected to lock-up periods during which the investors and entrepreneurs cannot sell their shares on the market immediately after the IPO, IPOs offer VCs several advantages. First, public companies remain going concerns, enabling VCs to take credit for investments that they made (potentially) long into the future. An IPO not only offers a VC a merit badge that can be promoted to entrepreneurs and limited partners, but it also enables the VC to leverage its contacts at the newly public company to help future portfolio companies in many ways (from acquiring customers and partners to initiating acquisitions).

Many stories have been written about the huge number of initial public offerings that got pulled in the second half of 2008. The markets were cruelly volatile and investors were stuffing money under their mattresses, making the prospect of selling new shares highly unattractive.

But going into 2009, there are dozens of stock sales stuck in a kind of I.P.O. limbo, not having been withdrawn but also unlikely to proceed until global markets stop convulsing.

A week before the end of 2008, there were 124 United States companies with initial offerings in the “pipeline,” valued at a combined $25.7 billion, according to Thomson Reuters.

(Read More)

By David Shabelman, The Latest from VC Ratings

We were trying to wait until the stock market showed some signs of stability before discussing the following report…alas. Anyway, Renaissance Capital LLC earlier this week came out with a detailed study seeking to answer the question: When will the IPO market return? The quick answer: The IPO market will stage “at least a modest comeback in January, 2009.” Worst-case scenario (which it seems prudent to discuss) is that IPO activity will not return until March of 2009, “and then sputter on for several months.”

While a strong stock market is typically necessary to encourage companies to go public, Renaissance argues that’s not always the case. When there is a period of heightened IPO activity, as there was from 1995 to 1999, followed by a decline in the broad stock market, subsequent IPO issuance is sluggish. However, when there is a period of lower-than-normal IPO issuance as was the case in the 1970s (the most recent period of prolonged IPO inactivity) and the last seven years, “a bounceback can occur without a strong overall stock market simply because there is pent-up demand for capital by private companies.” This is the scenario Renaissance expects will play out.

The good news for investors, if Renaissance is right, is that the most powerful returns will be seen when the market does come back because the quality of companies attempting to go public will be high and pricing will be favorable because the IPOs will need to be priced relatively low to attract investors.

See IPO report from Renaissance Capital