In the seven years since Deloitte & Touche and the National Venture Capital Association launched the first Global Survey to examine the views of venture capitalists around the world, the industry and the global environment has changed dramatically.
Venture capitalists and their companies are now committed to participating in the global economy and are more active across borders.
However, the overriding story of the past two years has undoubtedly been the global economic downturn. Conditions in the exit markets have been challenging and VC firms have felt the effects in the form of lower levels of investment in their funds. While firms adapted to the challenges by supporting their companies with additional investment rounds and raising smaller funds, now that the economy has begun to recover, we wanted to know how the venture ecosystem has fared and what the new normal might look like.
From February through March in 2011, we surveyed about 350 venture capitalists in the Americas, Europe and the United Kingdom., Asia Pacific and Israel. We wanted to know, first and foremost, whether VCs worldwide believed the IPO market was critical to the health of the venture capital industry. On a regional or global basis, we also wanted to know what, if anything, is getting in the way of a healthy, active IPO market.
The results are clear. VCs are very concerned about the lackluster IPO market and the potential for IPOs in the future. A vast majority of VCs believe that without the higher returns generated by IPOs, the exit opportunities offered by M&A alone are not compelling enough to draw LP interest over the long term.
If the market for IPOs thaws this year, as some believe it is doing so, it could be a turning point for bringing institutional investors back to venture capital, not just in the United States, but around the world. Yet the question remains, is it changing enough to create a healthy ecosystem for the industry?
Our survey last year highlighted the difficulty in achieving successful exits as the number one factor creating an unfavorable climate for venture capital.
Does the IPO Market Matter?
We began this year’s survey knowing that there was a lack of IPO activity. But we wanted to measure the impact of that lack on the long term health of the industry.
In our survey, 81% of all respondents agreed that an active IPO market is essential for the success of the venture capital industry in their country.
While the results may seem obvious, they underscore the importance of an active IPO market. The IPO market has had its ups and downs, but this downturn comes on the heels of a decade that saw a fraction of the venture-backed IPOs as were completed in the 1990s.
When VCs were asked to select the most important aspect of why IPO activity is essential, two were cited by a vast majority of respondents, far outweighing any other factors: the superior returns to LPs and the growth capital to support developing portfolio companies. Either way, VCs believe that healthy returns in the industry are predicated on an active IPO market.
U.S. Exchanges are Still the Listing of Choice
We’ve posited that the VC industry is global rather than local, but where the IPO market is located matters to the VCs, at least in some regions. A total of 81% of respondents said that having an active IPO market in their own home country was essential.
Not surprisingly, in the United States, where there has been a large and active VC and entrepreneurial community for many years, 91% of VCs deemed the U.S. IPO market a critical element of the VC industry. At the same time, 64% of U.S. VCs said that IPO markets in other geographies were not essential to the success of the U.S. VC industry.
Globally, 87% of respondents selected Nasdaq as one of the three most promising stock exchanges for venture-backed IPOs; 39% selected the NYSE; and 33% named the Shanghai Stock Exchange to round out the top three. Clearly, for VCs worldwide, the health of the U.S. IPO market matters.
What the results also show, however, is that an in-country IPO market is considered essential in three of the largest emerging entrepreneurial communities where the venture ecosystem is relatively newer: Brazil (88%), followed by China (83%) and India (81%). The ongoing development of the entrepreneurial community in these countries will continue to drive IPOs in those regions.
With a Sluggish U.S. Market, a Critical Part of the Ecosystem is Missing
A vast majority of VCs around the world still look to the U.S. exchanges to provide a healthy and vibrant market, yet 87% of U.S. VCs believe that the current level of IPO activity is too low and, just as importantly, no one felt that it was too high.
The U.S. is not alone. In every other country, except China, the majority of VCs felt the level of IPO activity in their own country or globally was too low. Clearly, China is benefiting from new markets opening up while the U.S. struggles with a dearth of IPO activity.
What Will it Take to Bring the IPO Market Back to Life?
In 2010, only 74 venture-backed companies, including 46 from the United States, had IPOs on U.S. stock exchanges. This begs the question: why aren’t there more IPOs occurring here and what needs to happen to improve the market?
We asked our respondents to select the top three factors that create a healthy and vibrant IPO market. The number one factor was the need for a healthy investor appetite for equity in public companies. Economic stability was the second most-cited factor. Adequate stock analyst coverage came in as the third most cited factor.
U.S. VCs also cited the need for a competitive investment banking community for IPOs and easier reporting for newly public companies. What is also revealing is what VCs did not cite as key factors for a healthy IPO market: more appealing companies with better technologies and the ability to move capital out of countries.
The big question for the venture capital industry then is: What will bring investors back to the table?
Already, the tide appears be turning. As of June 1, 29 VC-backed companies completed their IPO in the United States, and there were 42 VC-backed American companies in registration in the U.S. market.
This is in contrast to the 46 venture-backed U.S. companies that went public in all of 2010. The average age of companies that have gone public in 2011 thus far is 10.2 years, compared to 2001 when the average age was 6.5 years. As a result, there is a backlog of more seasoned companies waiting to go public, and now it appears the IPO market could restart.
The companies now in registration not only weathered the turmoil of the economic downturn, they survived when only VC and bank loans were available to them. The end result is that only now are these companies coming out to test the IPO waters.
On average, the companies in registration right now are more mature and perhaps more durable than IPO companies of the past; this may be the new normal.
Mark Jensen is Managing Partner of Technology & Venture Capital Services at Deloitte & Touche LLP and can be reached at email@example.com. Mark Heesen is President of the National Venture Capital Organization and can be reached at firstname.lastname@example.org.