Above the Crowd

Bleak VC Quarter? Why?

June 30, 2008:

Matt Richtel over at the New York Times wrote an interesting article last week titled, “Venture Investors Wrap Up an Unusually Bleak Quarter.”

The main data point that spurred the article is that this is the first quarter since 1978 that not one venture backed company went public.  I don’t aim to dispute the facts.  This is indeed true.  However, the article goes on to imply that the buyside doesn’t want the companies being backed by VCs.  This perspective is most strongly suggested by Paul Kedrosky, investor and the author of Infectious Greed, “There is nothing that the industry is producing that investors want…The stuff they’re investing in is idiosyncratic — it’s fun and appealing to them but Wall Street doesn’t care.”

Having had several conversations with mutual fund managers in the last three months, I personally disagree with this perspective.  Many funds are starved for growth and appreciation. Many of the leading large capitalization technology companies have seen flat stock prices for as many as seven or eight years. Without a robust IPO market, these investors are not able to balance this lack of growth in their current portfolios. Moreover, the investors themselves lack the exposure to the new trends and disruptions. At a recent Wall Street conference, several investors were visibly upset that the venture community was not bringing more companies public. I feel very strongly there is no a “demand problem” when it comes to IPOs.

So where is the disconnect? If it’s not a demand problem, what is the issue?

If you went back to say 1995 and asked any entrepreneur or tech executive, “what is your one key goal for your company?,” they would all say – “IPO”. This overwhelming desire to be a part of a company that achieved a public offering was universal. It mirrored an athlete going to the Olympics, or perhaps playing in the pros. This passionate desire to be public is completely gone in Silicon Valley. For reasons you could easily list – Sarbanes Oxley; 12b1 trading rules; shareholder litigation; option pricing scandals; personal liability on 10-Q filing signatures – it is simply not much fun being a public executive.

The Benchmark portfolio current has over 15 companies north of $50MM in revenues, and they are all private. This would have never happened in 1995 (even pre-bubble) where most of these companies would ALREADY BE public.

I don’t think we have a demand problem, we have a supply problem. No one wants to manage a public company.

15 Comments

  1. Bryan Scott July 1, 2008

    If you went back to say 1995 and asked any entrepreneur or tech executive, “what is your one key goal for your company?,” they would all say – “IPO”.

    Indeed, it seems most web entrepreneurs’ dream today is to sell to Google for $100M, not IPO at a $1B valuation.

    I recently spoke with an associate at an east coast growth-stage VC fund. He told me that they invest in companies with revenues of $5-100M. I traditionally viewed this range (especially the top half) as debt/mezzanine territory, not equity. It seems “growth-stage VC” has been redefined since SOX etc.

    Reply
  2. Charlie Federman July 3, 2008

    Bill,

    Welcome back to blogging, for years I enjoyed your insightful posts, and missed them for years too.

    Thinking about the emerging IPO debate, it seems to me a key issue is not the past performance of companies that have reached a critical mass, but the market’s perception of the growth potential of these firms. As we have learned, web/software companies prospects, in the public sector is the key determinant driving market interest.

    Looking at the great achievement of Benchmark in helping entrepreneurs grow at least 15 companies (in your existing portfolio!) to achieve revenue levels >$50mm, but how many of these firms, top and bottom line growth rates exceed 30%?

    Which of them are mining fundamental paradigm shifts like your seminal Ebay investment?

    Mobile and ‘Web 2.0′ opportunities have consumed great amounts of capital, spread over many hundreds of companies, but these investments have produced a surprisingly small number fast growing game changers.

    I agree there is a supply problem but see the dearth of IPO’s as a lack of supply of fast growing, companies riding fundamental paradigm shifts as the root cause. After all, the incentives are the same for all interested parties. Bankers love the fees, investors seek alpha returns, and entrepreneurs want to be rid of VC liquidation preferences.

    Reply
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  4. Steven Kane July 3, 2008

    i’m not sure i follow your logic. if there is no demand problem (makes sense to me) and no supply problem (witness the benchmark portfolio), it is easy to suppose that SOX and other “lifestyle” issues are the gating factor.

    except for one thing. as far as i can tell there is no shortage of talented pople who want to run or be officers or shareholders or principles or insiders of companies that are already public

    so if your analysis is correct then why aren’t great talented people being recruited from existing public companies to get healthy private companies listed?

    i’m not privy to enough info to be sure but at a distance i’m more with the infectious greed analysis — benchmark may be an exception but it stands to reason that the vast majority of vc fund portfolio companies are in no shape to be a sustainable public company — regularly growing their businesses and increasing earnings and margins etc.

    Reply
  5. Thomas July 3, 2008

    The internal audits that I have visibility into that are a result of Sarbanes-Oxley are a joke. Estimates just get moved to different areas. Paperwork is shuffled with a lack of real investigation. Management pressures finance. It never stops. Baby boomers have a high resistance to being regulated. Their main purpose in life is to get ahead by skirting the rules. If they can technically justify something, they’ll do it regardless of the larger ramifications.

    Reply
  6. Spencer Rascoff July 3, 2008

    Bill,

    Welcome back.

    I completely agree. It’s a supply problem not a demand problem. Obviously the buyside still has strong demand for successful pre-IPO companies — look at how many mutual funds and hedge funds are leading late stage private rounds. Two of Zillow’s VCs fall into this category — PAR Capital and Legg Mason.

    Others who have argued that it’s a supply problem frequently point to SarBox or RegFD. And clearly the more onerous regulatory environment has complicated things and made it more challenging to run a public company. But there are other challenges also — the grind of hitting quarterly numbers under a microscope, and of course activist hedge funds which are increasingly targeting tech companies in ways that they never used to — witness YHOO and CNET.

    Has anyone seen data on total VC$ raised per company before liquidity? I’m wondering whether it’s really true that web2.0 requires less capital. (That’s obviously the lore, but is it actually the case?) If so, then the IPO drought is less of a problem because employees and VCs can still earn healthy returns through M&A exits (which typically happen earlier and at lower prices).

    I agree with Bryan’s comment — “it seems most web entrepreneurs’ dream today is to sell to Google for $100M, not IPO at $1B”. That’s spot on. But it presupposes a small amount raised in order for the $100M sale to be a successful exit.

    Reply
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  8. Aruni Gunasegaram July 5, 2008

    Bill – Saw you mentioned on Fred Wilson’s blog, which I read often. Not sure if you remember me, but you were a judge on a MOOT Corp panel for my first venture, Isochron Data Corp., back in 1998 here at UT Austin.

    I’ve done a few things since then (feel free to check out the About page on my blog) the most important being having two kids!

    I just joined ATI a few weeks ago to help them with their Operations and Finance.

    Next time you are in Austin, let me know and if you have time, I’d love to meet up.

    With regards to this post, I agree with it being supply issue and entrepreneurs and directors alike not wanting to manage a public company. What would be interesting is to examine the social reasons behind that in addition to Sarbanes Oxley, etc.

    Aruni

    Reply
  9. Mark MacLeod July 7, 2008

    Bill,

    I agree that there is a supply issue. I have been a CFO for 4 VC-backed companies (on my 5th now). Private is good. I dealt with SOX compliance while integrating my 3rd startup into its acquirer. What a nightmare!

    The nightmare notwithstanding, I think we risk over analyzing this. It’s one quarter. The fundamentals of both early stage investing and late stage exiting are not changed. Despite the credit crunch, i-bank writedowns, recession threat, etc. It’s a timing issue and not a fundamental change.

    Mark

    Reply
  10. Jeff July 18, 2008

    Even if its expected to be a weak VC quarter, there is no need for entrepreneurs to panic. There are ways to self-finance a company using some creative tactics. Big huge advertising budgets and customer support centers are absolutely not needed anymore with the advent of social media in the past 4 years. See here… http://www.readtheanswer.com/index.php?RTA=web2

    Reply
  11. Ryan Graves August 20, 2008

    I love this challenge of the NYT. The optimist in me definitely is rooting for your theory over his! Great post.

    Reply
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