IPO exits set unbeatable low

For the first time in 30 years, there were no public offerings from a venture backed company. The National Venture Capital Association announced that the entire VC industry posted a donut for Q2. That brings to 5 the number of venture-backed IPOs in the first half of 2008. NVCA cites skittish investors, credit crunch, and SOX costs as the top 3 reasons for hitting rock bottom.

VCs are bankers - they raise a fund, buy into companies they think will grow in value, and then sell the company to generate a return to their own investors. VC's ability to generate returns directly impacts their ability to raise money for new funds. VCs can live nicely on management fees, but they really make their bucks when selling a company to either another enterprise as a merger or acquisition or to public shareholders as an IPO.

VC's love to hit home-runs and to win big. Out of 10 companies, only 2 or 3 will make a noteworthy return and the other 7 or 8 will either die or just stumble around. Nailing one Red Hat or Google makes for a great disbursement to fund partners and makes a rock star out of the VC. However, it looks like the days of huge multiples are gone and VCs may be forced by market conditions to change their behavior.

The M&A trend in security and virtualization is for buyers to grab technology early and build it into their own product suites for competitive advantage. (The selling company usually does not have a customer base that the larger acquirer doesn't already have, and smaller companies have less risk of incompatible corporate cultures.) This is in direct contrast to the VC model of a big return driven by IPO visions. The exceptions are international investments that hope to capitalize on other economies that are growing faster than the US, but it is not clear how well that strategy will work with creative technology companies.

I look for more VC-driven boards of privately held companies to more readily accept smaller acquisition flips, and to lose patience with entrepreneurs of stumbling companies that want to hold on for a few more years. Since VCs are in the business of investing in privately held companies I would expect that to continue, but I would also expect the behavior of VCs to change when hunting for an exit.