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Here’s the Cliff Notes version of one the main factors that’s been driving America’s economic growth for the past few decades. A couple of really bright kids from MIT, Caltech. or maybe Stanford get together and come up with a new killer app or some hot new tech gizmo. These wunderkinds then present their offering to venture capitalists. The VCs kick in a couple of million dollars in first round funding, enabling the kids to get all the bugs out of their offering and eventually, go public and bring their product to market. In the end, the young entrepreneurs and their backers pocket some serious money, a new technology company is formed, jobs are created and corporate America benefits from this game changing new solution.
That’s the way it used to work, anyhow, under a best case scenario. But not anymore. Consider: In recent years the number of initial public offerings (IPOs) by venture backed companies has declined to alarmingly low levels, culminating in the 2008 drought when only six companies entered the public markets, according to the National Venture Capital Assn.(NVCA). Venture capitalists invested just $3.0 billion in 549 deals in the first quarter of 2009, according to the MoneyTree™ Report from PricewaterhouseCoopers (PwC) and the NVCA on data from Thomson Reuters. Quarterly investment activity was down 47 percent in dollars and 37 percent in deals from the fourth quarter of 2008 when $5.7 billion was invested in 866 deals. The quarter marks the lowest venture investment level since 1997.
Why the drop off? It’s the economy and tight credit, of course. According to a statement made by Mark Heesen, president of the NVCA, "These numbers clearly demonstrate that the venture capital industry is not immune from the current economic downturn. Venture capitalists have slowed their investment pace in order to work with existing companies that are not able to exit the venture portfolio due to the shuttered IPO window and the weakening acquisitions market.”
Declines in the first quarter of 2009 extend across almost every industry sector in both the level of dollars and number of deals. The software sector received the highest level of funding with $614 million going into 138 rounds, a drop of 42 percent in dollars and 34 percent in deals compared to the fourth quarter of 2008. Internet-specific companies garnered $556 million going into 123 deals in the first quarter, a 31 percent decrease in dollars over the fourth quarter of 2008 when $804 million went into 180 deals. Other industry sectors that experienced significant investment dollar declines in Q1 2009 included Telecommunications (72 percent decline) Media and Entertainment (45 percent decline) and Networking and Equipment (47 percent decline).
“This capital markets issue is not just a venture capital industry problem; it is a U.S. economic concern,” Heesen said. “If America wants to maintain its economic leadership and continue to grow and innovate, we must reinvigorate the public markets and strive towards healthier IPO levels similar to that which our country enjoyed in the 1980s and 1990s. Without this activity, we can expect job growth to disappear over time.”
NVCA has advanced a number of proposals including tax incentives to get VC and IPO activities back on track, but realistically the boom times when VCs financed thousands of new IT, communications, Internet and biotechnology companies a year amidst an enormous amount of hype are not likely to ever return.
Still the most promising new technologies such as cloud computing and virtualization continue to attract VC funding. As an example, virtualization performance management startups such as BlueStripe Software, Embotics, Fast Scale Technology and Reflex Systems have raised $26 million in venture money.
Meanwhile modest apps such as StockTwits, which encourages Twitter users to share stock tips, are also receiving seed money—in StockTwits case $800,000 from Silicon Valley VC firm True Ventures. That firm has also provided seed money to startups such as SaaS-based Loopfuse, a sales and marketing automation firm which makes it easy to convert qualified leads into sales. Not too long ago the technology community used to excitedly await the advent of “the next big thing.” Those days have gone. The good news: those technology solutions and startups that do make it through the VC/IPO gauntlet will likely be best of breed.
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