As I often say, I grew up in and out of Silicon Valley with a dad in high-tech. So, early on I knew what venture capital is (along with “chips”, “boxes”, “burn rate” and other valley lingo). The valley has changed; most of the orchards are gone and Tully Road is lined with company headquarters not the stables I visited in my teens.
Some things haven’t changed: Steve Jobs, Stanford University and the dead (cell) zone between Sand Hill and Page Mill Roads on 280.
But I’ve been surprised recently by the number of VCs saying – publicly and on panels – that any company looking for funding needs to have an exit strategy based around likely corporate buyers. Basically, a company sale instead of an IPO. The basis? The practical reality is that VC backed IPOs (no, wait, all IPOs) have gotten fewer and harder to complete.
According to PWC in a recent report, during Q2 2010 the number of IPOs filed tripled to 39 (raising $16.6 billion) from 12 (raising $5.1 billion) in 2009. But that number was down from the comparable period in 2007 during which 79 deals raised $21.1 billion. And the numbers being filed have been tapering each month. 15 IPOs were pulled or postponed in the latter two months of the quarter.
While the stats on VC-based M&A exits I’ve heard have ranged – the reality is that company sales are now the prevalent exit strategy for most VC funds. (And, to be fair, I think that any stats with respect to recent exits has to consider the impact of the bad economy over the past two years; the IPO market may not have been open but many companies were going belly up and not deprived of capital due to market issues – though those definitely existed as well – but rather operating ones).
So, anyone can quote numbers. What is the deeper analysis?
Key trends have changed:
1. Being a public company is much more expensive than it was ten years ago (I heard a quote from a lawyer yesterday saying that SOX compliance alone can cost $1 million per year these days).
2. Law suits, director liability, increased governmental encroachment into business affairs, complicated tax structures, uncertainty of future regulations and taxes…
3. I know my part of the world: smaller middle market or growth companies. Scale and deep pockets help in an economic downturn with more limited access to capital.
4. The larger companies are sitting on pools of cash (if lucky) and willing to buy growth.
5. The IPO market is still tough. VCs and their investors don’t always want to, or can’t, wait.
6. Even after a company completes an IPO, it often takes a year or two for the investors to get liquid on their stock – assuming it is still a decent valuation. A sale gets investors all/most of their liquidity at closing.
7. The role of the research analyst has changed (contact me offline on this point, if interested).
8. VC funds have had a bad ten year period overall (with the industry, though not all funds, being down for the period). They need to show some positive returns and M&A has been more closable than IPOs.
I’ll stop there because otherwise I’ll venture too far into opinion and politics.
But the practical lesson is that M&A is now – correctly or incorrectly – viewed as the probable exit strategy. You better know who might be a good potential buyer for your company when meeting with investors.
Saying that an M&A exit was the expected outcome used to be heresy. Now it’s the “new normal” (with a bow to PIMCO for the phrase).
Photo credit to Ana Berman