SF Venture

Venture Exits – Year Ends With Rise in IPOs

After much debate on the death of venture, the data for the year pointed to positive prospects for 2007. 

In 2006, 58 venture-backed IPOs raised a total of $5.3 billion, up from $4.5 billion in 2005, according to Thomson Venture Economics and the NVCA.   The 4th quarter of 2006 showed 21 IPOs. 

M&A yielded $16.6 billion in 2006, up slightly from $16.1 billion in 2004.  Average disclosed deal value for the year was $114 million in 2006, up from $96 million in 2005.

The year ended with a boost from Google’s $1.65 billion acquisition of YouTube.  This transaction distorted the numbers in Q4, which showed a decline in the number of deals, but an increase in the aggregate value.  Net returns from M&A continue to be mixed.  Looking at Q4 of 2006, out of 23 deals, 7 returned more than 10x the amount invested, 8 returned more than 4x the investment, one 1x-4x, and 7 less than the amount invested. 

What are the exit prospects for 2007?  We see all the signs of a receptive IPO market.  IPOs from Q4 mostly performed well in the aftermarket.  Anecdotally, we understand there are at least a half dozen reasonably high profile technology IPOs in the pipeline for the first half of 2007, including NetSuite. 

What are the dynamics for venture investment in 2007?  Within our deal flow, we saw a higher number of companies with good teams, plans and initial results at the end of the year than we’d seen in many years.  Unfortunately, some of the better ones found other VCs willing to pay higher prices than we’ve been seeing on average in 2006 or 2005.  We don’t believe the exit prospects have improved enough to justify much price inflation.  Of course, the true test of prices paid for new investments in 2006 and 2007 will be the IPO markets at the end of the decade.  It’s all about finding the few deals that return 10x or greater.  Prospects for creating those hits appear higher than we’ve seen in years. 

Is Venture Broken? - No

I’m a bit late to the part of reactions to the Sevin Rosen announcement that it was ending after its 10th fund and the related New York Times Article.  I felt compelled to post after reading a series of posts and comments on Fred Wilson’s blog.  I have seen no commentary that acknowledges the underlying math and attempts to take a constructive look ahead.

First, the math is simple.  The vast majority of returns to limited partners of venture firms have come from the value created after IPO.  Some funds have made money through M&A, but YouTube is the exception, not the rule.  However, M&A is not enough to drive aggregate returns to levels much above public market returns. 

Let's not delude ourselves. If you invest $20-40 million and take 5 years to build company from nothing to $20-30 million in revenues and profitability, selling out for even $150 million does not seem to justify the effort and risk.  Buyers typically bury fail to grow acquired technologies.  The goal of venture exercise is to create new, large companies. 

Looking at the long history of venture, the vast majority of growth in revenues and value occurs after IPO, with the IPO validating new markets and/or competitive position against incumbents. Given IPO hurdles, one could argue that the venture market will remain "broken" until there is a more receptive IPO market.  Fortunately, there are signs that the IPO market is returning to accept companies with revenues under $50 million.  Recent deals like Riverbed and Acme Packet have demonstrated strong after-market stock performance.  Failure of bubble IPOs created a fear of investing that has lasted many years.  If investors see a few deals working, the mood could turn from fear back into greed, with a reasonable number of technology IPOs introduced each year. 

VC-Inside Out Launch

The first two episodes of VC-InsideOut, a podcast program on the Venture Capital industry developed and produced by the investment professionals at Levensohn Venture Partners, are available for streaming and downloads on the web at www.VC-IO.com.

VC-InsideOutPascal Levensohn opens a window into the venture capital industry through constructive dialogue and interviews with leading VCs, entrepreneurs, and other influential leaders involved with the VC world.  VC-InsideOut episodes feature original content developed and produced by Pascal Levensohn, Keith Benjamin, Kip Sheeline, Steve Reale, and Jeff Karras on a range of subjects relevant to the venture capital industry.

Typical episodes run between 10 and 12 minutes.  You can stream the content from our website, or download it to iTunes or your favorite media player.  By clicking on Subscribe, you can be notified of new episodes when they are added to the VC-IO.com website.

VC-InsideOut kicks off with two separate series, the Governance Series and the Entrepreneur Series.

About the VC-InsideOut Governance Series

How and why are VC boards different from other boards?  What are some of the common problems faced by VC-backed company boards? Are there early warning signs of trouble in the board room? What are some of the signs of effective and ineffective venture boards and directors?  VC-InsideOut tackles these and other important governance questions head-on in this series of interviews and editorial commentary on the state of VC boards.  Each episode makes clear recommendations about best practices that can be useful to VCs and entrepreneurs in the field.

About the VC-InsideOut Entrepreneur Series

The VC-InsideOut Entrepreneur Series is focused on enabling entrepreneurs to gain access to the information, insights, and tools needed to build successful technology companies.  Leading entrepreneurs, venture capitalists and other service providers share their experiences on the "ins and outs" of creating an idea, business plans, hiring teams, raising capital, and building businesses that scale.

Will the US IPO Market Ever Recover? Can AIM Provide A Viable Alternative?

Quarterly exit data has just been released by Thomson Venture Economics and the NVCA.  Although there was an increase in IPO activity, there overall trend remains flat. 

In the second quarter of 2006, 19 venture-backed IPOs raised a total of $2 billion, up significantly from both the first quarter of 2006 and the second quarter of 2005. 

M&A activity was $3.2 billion in Q1 of 2006.  There were a total of 86 M&A deals with 34 disclosing values.  Average disclosed deal value was $95 million in Q2 of 2006. These numbers are down somewhat sequentially and from last year.  Roughly 29% of those deals returned more than 4x the investment, 42% returned 1x-4x, and only 29% less than the amount invested.  It took almost 6 years on average between founding and M&A exit. 

Levels are still not high enough to provide venture funds returns in excess of competing asset classes, including buyouts and hedge funds. 

Three of these IPOs were US companies on foreign exchanges, 2 on London’s AIM (Alternative Investment Market) and 1 on the London Stock Exchange.  We are encouraged about what we’ve been learning about AIM, which could provide a reasonable alternative for venture-backed companies to go public. 

What is AIM?  It was created 11 years ago as an affiliate of the London Stock Exchange to list smaller companies.  The structure is friendly to smaller stocks.  UK investors receive tax benefits by holding long-term, discouraging the volatility typical on NASAQ.  Relative to NASDAQ, where Sarbanes Oxley makes disclosure problematic and expensive, disclosure rules on AIM are reasonable.  Given Spitzer’s hobbling of the research function, it’s impractical to list a company on NASDAQ with a market capitalization of less than $500 million.  AIM is geared to companies below $100 million.  Until recently, company sizes, exchange volumes, and international investor interest has been low to modest.   A few US technology companies have listed on AIM, allowing financing, but less trading liquidity than NASDAQ.  Liquidity for venture investors has been enabled more secondary offerings than open-market sales.  That appears to be changing, with activity increasing on AIM. 

We’ve wondered how venture-backed companies get large enough to get on NASDAQ.  Historically, NASDAQ’s structure supported more risk taking behavior, allowing companies with modest revenue levels to go public with growth stories, using IPO proceeds and the marketing event of on IPO to validate competitive positioning against larger legacy companies.  Over the last few years, we’ve observed most technology companies have struggled to scale businesses without the help of an IPO with buyers of technology cautious about dealing with private companies.  A few companies have crossed the marketing chasm by taking more time, raising more money privately or merging with other private companies.  If AIM can show it can market technology growth stories, AIM could provide a bridge between venture and NASDAQ, with successful companies achieving the scale needed to move over to NASDAQ.

Based on discussions with investment banks, we expect more US technology companies to list on AIM and will be monitoring trends in the market closely. 

Venture Exits Up In Q1:06

In the first quarter of 2006, 10 venture-backed IPOs raised a total of $540 million, compared to 10 deals in 2005, according to Thomson Venture Economics and the NVCA.

M&A activity was $4.8 billion in Q1 of 2006, up from $4.4 billion in 2005. 

There were a total of 95 M&A deals with 42 disclosing values.  Average disclosed deal value was $112 million in Q1 of 2006, up from $94 million in 2005.  Roughly 33% of those deals returned more than 4x the investment, 50% returned 1x-4x, and only 17% less than the amount invested. 

It took almost 6 years on average between founding and M&A exit. 

With a continuation of this level of M&A activity, but without more IPOs, venture fund returns can be positive, but not extraordinary. 

Anecdotally, we have been seeing a significantly improved quality of companies seeking funding in the first quarter.  Emerging start-ups are demonstrating more revenue traction, reflecting a more stable economic environment.  We’re also pleased to see more capital efficient business models.  There are a few signs of a fresh supply of venture money chasing some sectors to unreasonable deal prices.  Most of the Web 2.0 categories already appear too crowded with negligible barriers to entry.  Examples include the video sharing space.  At least consumers and advertisers are flocking to these sites.  Fortunately, the vast majority of technology deals are at least attempting to strive for differentiation in reasonable market segments.  Enterprises are still increasing technology spending. 

As companies take advantage of lower costs of start-up and better demand, we would expect to see shorter paths to exit.  The combination should help venture returns as the 2005 vintage funds progress through their investment periods over the next 3-4 years. 

Venture Exits – Year Drags to a Close – Prospects Better for 2006

In 2005, 56 venture-backed IPOs raised a total of $4.5 billion, down 40% from $11 billion in 2004, according to Thomson Venture Economics and the NVCA.  Google raised $1.2 billion in 2004. 

M&A activity was $14.4 billion in 2005, down from $15.4 billion in 2004. 

Average disclosed deal value was $91.5 million in 2005, up from $83.4 million in 2004.  Out of 154 deals, roughly 1/3 returned more than 4x the investment, 1/3 1x-4x, and 1/3 less than the amount invested. 

What are the prospects for 2006?  Anecdotally, including our own portfolio, there appear to be more companies positioned for attractive exits, even IPOs.  It's been tough for companies to grow against entrenched competition.  As a consequence, the current graduating class of companies boasts more differentiable technologies and more efficient business models.  This should help exits in 2006.

Good Article On IPO Market

Mark Boslet of Dow Jones just wrote a good overview of IPO prospects. He notes that some U.S. venture-backed companies are considering listing on London's AIM Exchange.  It provides both perspective and hope for the IPO market. 

Download ipo_drought_in_us_leading_vcs_abroad.doc  

Venture Trends – Q3 numbers encouraging, but not exciting. Will the IPO market return?

Venture data for the third quarter was reported in line with the trends of the first half.  We’re starting to see more dollars returned from venture than invested, albeit modest returns. 

According to VentureSource, U.S. Venture Capital Firms raised almost $16 billion for the first nine months of 2005.  This seems to match the current investment pace, with slightly more than $16 billion going into companies thus far this year.  Fortunately, liquidity through M&A is rising.  Some 82 U.S. venture-backed companies were acquired for $21 billion in aggregate for the first nine months of 2005.  In the third quarter, the median amount paid at almost $60 million.  IPOs have only generated over $1.5 million thus far in 2005. 

Without more IPOs, it will be hard to generate more exciting venture returns.  Is there hope to see more IPOs in 2006?  My contrarian instinct says yes.  I can list all the reasons why not, including regulatory costs, risk adverse investor attitudes and the lack of research coverage.  Still, there appear to be more venture-backed companies that are reaching revenue and profitability run rates that should be more attractive to IPO buyers.  Some technology sectors, like security are seeing market growth, but have few public company vehicles for investment.  Without a new technology wave, it’s hard to believe we’ll see a big swing in the IPO market, but there is room for positive surprised in 2006. 

Venture Trends Positive With Activity Steady In Q2

According to DowJones, there were 524 equity financing rounds raising $5.4 billion for U.S. venture-backed companies in the second quarter of 2005.  This was down a bit from last year’s second quarter, but this was the highest level in the last four quarters.  Within these numbers, there was an increase in later staged deals, which accounted for 210 deals and almost $3 billion of the total.  Download vc_spending_second_quarter.pdf

I was quoted in an article accompanying the release of this information, suggesting that the reason for the relative slowdown in funding for earlier stage deals is a healthy shift to more capital efficient start-ups.  It’s good to see initial dollars invested per company declining.  It allows for profitable venture investments with exits from M&A, which remains more likely.  Average deal prices for the second quarter approached $70 million. 

"If you are getting $70 million out, you want to make sure you're only putting in $20 million to $30 million," Keith E. Benjamin, a managing director with Levensohn Venture Partners, said.

The relatively stable pace of funding activity this far in 2005 is encouraging.  After the refresh of capital for new funds raised since last year, there had been some speculation that there would be a rush to spend money.  This has clearly not happened.  I’d like to believe that this reflects lessons learned.  I think it’s also an acknowledgement that there are fewer new technologies areas to attract new investment.  While there may be fewer deals, I see a higher quality of capital efficient companies raising money to develop viable new markets. 

I’d expect to see some growth in aggregate venture investment through 2006, as the venture community gets back to a spending pattern that matches exit opportunities. 

After a decade of greed, we’re living in a decade of fear…

The 90s were driven by greed as we chased technology stocks to temporary wealth.  The mood was good while it lasted.  Aggressive investing was addictive. 

The crash shocked the investment community.  If that wasn’t bad enough, 9/11 caused us to be concerned for our personal safety.  This sustained period of panic and pessimism has created the equivalent of a low-grade fever that infects our attitudes and actions. 

While yesterday the NASDAQ Index just reached a 4-year high, it’s still 50% below its peak in March 2000. 

Today, any risk feels bad.  Individuals run quickly from stocks that show volatility.  Investors have generally moved have far away from risk as possible.  Venture capitalists are still taking risks, but returns continue to suffer a shortage of rich exits, with some improved liquidity from M&A.  Hedge funds and buyout funds are attracting massive amounts of money with the promise of beating mediocre returns for taking long positions in public equities.  Real estate looks so safe that it feels like another bubble. 

Consumers are borrowing heavily and spending on new toys from iPods to retro hot rod Mustangs.  This may provide some comfort in contrast with disturbing world news and slower career progress at home. 

Corporations are still shy of spending on new technologies.  Fear continues to drive purchases of security tools to deal with persistent threats.  For technology designed to boost productivity, CIOs are less likely to start big projects and more likely to allow individual professionals and/or departments to buy hosted applications. 

The London bombs are yet another reminder of the ongoing battle between worldviews.  We are also being forced to take sides on domestic issues.  Last year’s election started the showdown between red/blue, conservative/liberal, and the religious right/left.   This week’s forum is the Supreme Court.  The scary part of these debates is that there does not seem to be room for moderation.  Great leaders in the past have brought the country together.  We appear to be dividing ourselves from the rest of the world and each other. 

With these serious distractions, no wonder it’s difficult to get excited about the next new technology.  Fortunately, the web is working again with a second wave of economic activity with more personalized commerce.  The rapid rate of blog creation is also providing a healthy outlet.

While the U.S. may be suffering through a decade of fear, emerging markets around China are starting to enjoy a decade of greed with the help of positive demographic and political trends.  This is attracting more U.S. VCs to head east for this cycle.    

Can the next decade provide an easier path for life, liberty and the pursuit of happiness back home?  I don’t yet see the catalysts to support another decade of greed.  My nature remains to be naturally optimistic, but I’ve been training myself to keep expectations low enough to appreciate whatever happens.