Bubbles No More, We’ve Gone Through The Cycle, Says VC

Does the venture industry require public investors and acquirers to avoid succumbing to speculative bubbles?

That’s a debate point that seems to have strong proponents on either side. In the first camp, believers in the magic of innovation and the dynamics of disruptive technology argue that top-tier entrepreneurial companies will prove their worth over time, beating out established competitors and pioneering entirely new industries.

In the second camp, skeptics are more prone to follow the money. If success were measured by the impact that venture-backed startups have had on everything from social networking to pharmaceuticals, then sure, VCs have done extraordinarily well.

But venture capital is also about returning money to limited partners.

By that measure, VC performed fabulously in the mid-to-late 1990s, when public investors willingly assigned lofty valuations to unproven businesses. Since then, overall returns have disappointed.

Against that backdrop, it’s refreshing to see acquirers and investors in exit-ready venture-funded companies feeling bubbly again. This week has brought a flurry of indicators that VC-funded companies are gaining cache, with M&A prices up and private placements reaching unprecedented valuations.
Here’s a brief recap of some of the more effervescent deals and recent data points:

  • To start with the obvious, there’s the $50 billion Facebook deal, with Goldman Sachs investing $450 million in the company at a private valuation high enough to make one wonder why we ever thought IPOs were the end-all, be-all for generating returns. As New York Times columnist William Cohan’s commentary says: “If General Electric, with 2010 revenue of around $150 billion, traded at a similar multiple of revenue, it would be worth $3.75 trillion instead of $200 billion.”
  • Then, there’s M&A. New data published by peHUB parent Thomson Reuters and the National Venture Capital Association showed that last year saw more venture-backed M&A exits since they began collecting data in 1985. The report counts a total of 420 deals last year.
  • Plus, IPOs are rebounding too. For full-year 2010, there were 72 venture-backed IPOs, the biggest year for activity since 2007, according to Thomson Reuters and the NVCA. The fourth quarter ended with 32 venture-backed IPOs, more than double the number of IPOs seen during the third quarter of 2010 The quarterly volume was driven by 17 Chinese companies funded by U.S. venture capital funds that went public on US exchanges.
  • Oh, and let’s not forget Groupon. After turning down a reported $6 billion acquisition offer from Google, the discount group buying site is making fast progress to closing a $950 million private funding round.

Is it a harbinger of more to come? VCs certainly seem to be feeling more optimistic.  Earlier this week, I spoke with Justin Perreault, a general partner at Waltham, Mass.-based Commonwealth Capital Ventures, who says it looks like the venture industry has turned a corner.

“I truly do think it’s a cyclical business and we’ve seen the trough of the cycle,” he says. “We’re going to look back two or three years from now and the venture business is going to look completely different.”

Perreault says he expects venture industry returns to pick up more based on the strength of portfolio companies than on a re-inflated bubble. With the bar for companies going public now higher – with investors preferring revenue of $100 million-plus and current or near-term profitability – it’s taken a while for venture-backed startups to reach that kind of scale. But with favored venture sectors such as cloud computing, software-as-a-service and social media enjoying rapid growth, there are plenty of companies that could likely pull off very successful offerings.

Still, I’d like to think a little speculative fervor among institutional investors and acquirers could also a long way toward juicing venture returns.