SF Venture

Exit Data Dark For First Quarter - Another Cycle Begins

The credit-related traumas impacted exit activity in the first quarter, with only 5 IPOs and 56 M&A deals for venture-backed companies, down sharply from recent levels. 

We don't expect the IPO market will recover until after the election.  We would still expect modest volumes of acquisitions, albeit at lower prices.  Clearly, this is bad for existing venture investments,  stretching out returns. 

Anecdotally, we have not seen pricing of venture rounds come down to reflect these market conditions.  In some areas, like new media, where pricing has appeared excessive, there should be a meaningful correction.  Later stage valuations are also ripe for adjustment.  Generally, we expect pricing of venture rounds to come down over the next few quarters. 

This data marks a turn in the typical cycle.  We saw a similar price correction at the beginning of the decade after the combination of the bursting bubble and 9/11.  We made some of our best investments during that recovery period.  Prices were reasonable and companies needed to find more compelling marketing opportunities while maintaining capital efficiency.  We see the same circumstance starting in 2008, where lower pricing will provide a good start for new investments. 

Spitzer's Fall - Opportunity To Correct His Mistakes

I cannot restrain from rejoicing at Eliot Spitzer's resignation today.  For years, I have been distressed by the damage he has done to Wall Street.  Now that his credibility has been destroyed, I hope we can revisit his actions against Wall Street and consider at least partial corrections.

The public markets have never fully recovered from the combination of Spitzer's crusade and the layers of bureaucracy now burdening public companies courtesy of Sarbanes & Oxley. 

What did Spitzer do wrong?  He was successful at bringing cases that created headlines and furthered his political career at the expense of others.   He claimed that because of a structure that allowed communications between bankers and analysts, investment recommendations suffered because of a perceived conflict of interests between issuers and investors.  He needed to blame somebody and create rules, even if those rules to hamper banker/analyst communications didn’t provide any benefits.  Clearly, bad recommendations were made in the 90s.  However, the vast majority of market participants were honestly trying to make money for both issuers and investors.  In fact, it was constructive to have bankers and analysts share perspectives on companies.  The reality is that capital markets are naturally self correcting and did not need his help.  When bankers or analysts lose money for clients, they eventually lose their jobs.  Communication between them is irrelevant.  The bursting of the bubble naturally weeded out many positions.  Have the new rules created any benefit for investors?  No. We’ve still seen IPOs succeed and fail, with analysts being right and wrong. 

Spitzer and others have only succeeded in hampering the IPO process.  At the beginning of the process, the separation of bankers and analysts creates inefficiencies and often miscommunications to investors.  The auditors are so afraid of making a mistake and still confused by evolving accounting rules that they force slow and costly processes.  Sarbanes Oxley preparation layers on even more paperwork with questionable benefits.  Once public, the full disclosure rules hamper communication between companies and investors.  Companies need to be so careful that they are pushed to say less to everybody.  All of this leads investors to remain cautious on IPOs, particularly technology IPOs. 

Political interference with the public markets has exaggerated volatile conditions.  Despite all of the structural challenges to going public, we finally had a receptive year for technology IPOs in 2007.  At the end of last year, I’d hoped to see a continuation of positive conditions.  I underestimated the market’s volatility and the unraveling credit crisis.  We’ve seen the class of 2007 technology IPOs has been generally guiding estimates down, scaring investors away quickly.  It may take reports from both the first and second quarters to find a bottom.  With some market confusion possible around the elections, it may take until the end of 2008 to see a recovery in the IPO market. 

Is it too late to correct these structural problems?  We’ve seen attempts to soften Sarbanes Oxley, which may be possible with the next administration.  Similarly, why not also soften the rules around investment banks? 

Venture Exits Rise in 2007

In 2007, 86 venture-backed IPOs raised a total of $10.3 billion, up from 57 IPOs raising $5.1 billion last year, according to Thomson Venture Economics and the NVCA.  Of this total, there were 47 Information Technology, raising $6 billion in 2007.

As of December 31, 2007, 58% of those IPOs were trading at or above offering price. 

The value of M&A deals rose significantly.  There were 304 deals disclosed in 2007 worth $23.7 billion, compared to 363 deals worth $17.1 billion last year.  Average disclosed deal size jumped to $176 million, compared to $111 million last year.

All of this occurred despite the volatility in the public markets associated with the credit crunch.  IPO activity fell off in December, but we view that as more a sign of investor fatigue than of a lack of demand for technology IPOs.  In 2008, we believe public market investors will continue to pay a premium for growth.