IPO crisis goes beyond credit crunch

There were no venture-backed initial public offerings in the second quarter of 2008. The last time this drought occurred was 1978 when the country was in a period “of malaise,” coming out of the oil embargo and significant inflation.

Our economy is not much better off today. Back then the venture industry had only a small fraction of the assets under management it does now. There was no way to predict the dramatic economic contribution that these venture-backed companies would make in the ensuing decades. We know now, as more than 10.3 million jobs and 18% of U.S. GDP is attributable to these companies.

Unfortunately, the lack of IPOs in the second quarter of this year is a “canary in the coal mine,” as this time around the problem goes beyond cyclicality. The IPO is becoming a less attractive exit option for venture-backed companies, and we need to reverse this trend quickly or suffer long-term consequences.

During the period 1991 to 1997, there were 1,353 venture-backed IPOs. Yet from 2001 to 2007 there were just 385. Some of this decline can be attributed to the bursting of the technology bubble, but the fact remains that the bar to become a public company in the United States today is very high—too high for many worthy young entities.

In a survey of more than 660 venture capitalists conducted by the NVCA in mid-June of this year, two-thirds of the respondents believed that venture-backed companies are less likely to want to go public today than they were just three years ago. There are several reasons for this:

• The cost of Sarbanes-Oxley has delayed or discouraged companies from the public markets. Despite the SEC implementation extensions for smaller cap companies, we understand anecdotally that the investment banks and accounting firms are requiring SOX compliance as a pre-requisite for taking on clients, regardless of size.

During the period 1991 to 1997, there were 1,353 venture-backed IPOs. Yet from 2001 to 2007 there were just 385.

Mark Heesen

• The once robust investment banking business of taking small companies public, dominated by Alex Brown, Robertson Stephens, Montgomery Securities and Hambrecht & Quist is no more. The result: The road to IPO is longer and harder than ever. The median age of a company from founding date to IPO hit an all time high of 8.6 years in 2007.

• Once public, there is very little or no research conducted on small cap companies, which certainly doesn’t help the demand for these securities. And the cost of Sarbanes-Oxley moves from a one-time lump sum to an annuity that takes up to $1 million each year off the bottom line. While everyone understands the importance of strong corporate governance and transparency, many CEOs have made the determination that going public is just not worth it.

The implication for the venture capital industry and its institutional investors is obvious. While the M&A is a respectable exit, it is the IPO that provides the stellar returns that have allowed the venture capital asset class to consistently outperform the public markets. Limited partners will ultimately suffer if the venture-backed IPO does not recover.

On a macroeconomic scale, the consequences are even more concerning. When a company goes public it is positioning itself for growth, and that means fuel for U.S. jobs, revenue and capital market value. Imagine the economic loss if instead of going public, companies like Cisco, Federal Express, Genentech, Google and Intel decided it was just easier to become acquired.

The second quarter of 2008 should be a wakeup call to policy makers, regulators and private sector participants of the capital markets. We need to start talking about a problem that isn’t going to go away with an economic rebound. The venture-backed IPO is an endangered exit and we need to protect it at all costs or risk losing more than just a quarter’s worth of value.

Mark Heesen is president of the NVCA. He may be reached at mheesen@nvca.org.