Year in Review: Top 10 Surprises in 2012

The future is always easier to predict in hindsight.

That principle applies particularly well to the venture industry’s performance over the past year. Much of what industry insiders had expected going into 2012 turned out quite differently. Optimistic projections for a roaring Facebook IPO and a robust pickup in technology M&A, for instance, gave way to a more disappointing reality.

For various VCs and firms, 2012 also provided plenty of surprises, from a high-profile sex discrimination suit to the departure of one of the industry’s best-known investors. And on the fundraising side, it was a relative newcomer who walked away with one of the largest fund closes.

Here, we take a look at some of the year’s most unexpected developments.

Facebook Flops

The social networking site’s May 18 IPO was supposed to be the social media event of the decade. With a valuation periodically exceeding $100 billion in private markets, Facebook was expected to go even higher following its public debut. As the eight-year-old company prepped for its $10 billion offering, the largest venture-backed IPO ever, the question most asked was: How high will it go?

The more appropriate question should have been: How low? After closing right around its offering price in first-day trading, Facebook shares shed value rapidly in subsequent weeks. In November, Facebook was trading for just about half its first-day valuation.

Still, Facebook’s early investors have limited cause for complaint. Even at a valuation of about $50 billion, rather than $100 billion-plus, early investors such as Accel Partners, Peter Thiel and The Founders Fund have raked in some of the largest returns in venture capital history. And Facebook’s stock gained momentum in December, with shares up nearly 50% from their post-IPO lows.

The Enterprise Soars

While consumer-facing Internet companies delivered an underwhelming performance on public markets, enterprise software providers by and large did very well. Of the venture-backed companies that went public on U.S. exchanges in 2012, at least eight were software businesses with an enterprise focus.

Some of those companies did extraordinarily well in their IPOs and initial months of trading. For instance talent management software provider Workday, which went public in October, was recently valued at about $7.6 billion.

Others that have sustained billion-dollar-plus valuations include next-generation firewall provider Palo Alto Networks (recently valued at about $3.6 billion), enterprise IT automation software provider ServiceNow (recently valued at about $3.6 billion), and business analytics provider Splunk (recently valued at about $2.6 billion).

Zynga and Groupon Implode

In 2010 and 2011, Groupon and Zynga were venture capitalists’ most-talked-about growth stories. Zynga, founded in 2007, rose to become top dog in the newly emerging social gaming space, with games such as Texas HoldEm Poker, Farmville and Mafia Wars attracting tens of millions of daily users.

Groupon’s rise was even more rapid. The Chicago-based company, which launched its daily deals platform in 2008, found itself in the unusual position in 2010 of rebuffing a $6 billion buyout offer from Google—on the grounds that it wasn’t enough money.

Both companies went public in late 2011, with Groupon securing an initial market value of nearly $13 billion and Zynga valued at about $7 billion. Though both had initially planned larger IPOs, the scaled-back offerings still ranked among the largest of the year.

In 2012, however, the outlook grew bleaker. Shareholders bailed out quickly following reports of declining revenues and widening losses. Today, shares of both companies are trading below $3, with recent valuations standing below $2 billion.

Tech M&A Stalls

Venture capitalists went into 2012 fairly confident that acquisition volumes and prices would rise from year-ago levels, buoyed by demand for hot startups in such sectors as social media and cloud computing. Yet things didn’t work out that way.

The number and disclosed value of venture-backed acquisitions fell dramatically year-over-year in 2012. In the first three quarters of the year, there were 88 acquisitions of venture-backed companies with disclosed valuations, according to Thomson Reuters and the National Venture Capital Association. That’s a sharp dip from the first three quarters of 2011, when there were 140 such acquisitions. Disclosed deal value is also down—it totaled $17.1 billion in the first three quarters of 2012, down from $20.4 billion in the same period a year earlier.

It’s not just venture-backed companies either. For the first nine months of 2012, aggregate technology deal value—including purchases of both public and private companies—was $86.7 billion, down 40% from $145.2 billion from 2011, according to Ernst and Young. That said, there were some large venture-backed acquisitions in the mix, such as VMware’s $1.26 billion purchase of Nicira Networks, Microsoft’s $1.2 billion bid for Yammer and Facebook’s $1.0 billion offer for Instagram.

The fourth quarter, though slower, also provided at least one billion-dollar-plus deal, Cisco System’s planned acquisition of Meraki, a provider of wireless networking equipment, for $1.2 billion.

Robots Get Some Love

For the last couple of years, venture capitalists have showered their largesse upon the software industry and pretty much treated the hardware sector like yesterday’s congealed oatmeal. Yet for acquirers, hardware plays, in particular those with a robotics component, have had more appeal.

A case in point was one of the first quarter’s largest venture-backed acquisition announcements, with Amazon.com’s $775 million purchase of Kiva Systems, a North Reading, Mass.-based maker of automation technology systems for distribution centers.

Kiva, which uses armies of robots to scurry around warehouses gathering products, was one of a few companies with a hardware component to raise venture funding, securing more than $20 million from Bain Capital Ventures and other backers.

A few months later, robotics investors scored another exit when robot vacuum maker iRobot acquired rival Evolution Robotics for $74 million.

Kleiner Perkins Goes to Court

Venture capital has a reputation as a clubby industry, and partners work to cultivate the impression of getting along harmoniously with fellow VCs. That was one reason why Ellen Pao’s lawsuit against Kleiner Perkins Caufield & Byers came as such a shock to the industry.

Pao, a partner at Kleiner Perkins, filed suit against the firm in May, charging sexual harassment and discrimination. The suit alleges that former Kleiner Perkins Partner Ajit Nazre made sexual advances to her and worked to harm her career once she rebuffed him.

Pao, who joined the firm in 2005, also alleges that Kleiner Perkins engaged in systematic discrimination against women, allowing female junior partners fewer board seats and investment sponsorships than male junior partners and allocating them a smaller percentage of profits.

Kleiner Perkins’ legal response to Pao’s complaint refuted every claim made against it, providing ample detail for a seven-page document. The firm also criticized Pao’s on-the-job performance, citing notes from prior reviews that she was “too territorial” and “had a sense of entitlement.”

Kleiner Perkins tried to move the case into arbitration in July, but a judge ruled not to allow it. The firm appealed the decision. At the end of 2012, the case remained far from resolved.

Pao, meanwhile, is no longer actively employed at the firm, although the circumstances of her departure are a subject of dispute. In October, Pao posted on the website Quora that she had been terminated from her post.

Kleiner Perkins responded that the post was misleading and that no one was fired. Rather, it said, the firm approached Pao to “facilitate her transition,” over an extended period of time, out of the firm.

Moritz Scales Back

Legendary venture capitalist Michael Moritz told limited partners in May that he is stepping back from the daily management of Sequoia Capital due to a rare and incurable illness.

Moritz, 58, was a journalist for Time magazine before joining Sequoia Capital in 1986. He has long been the face of the firm and led its investment in Google, perhaps its most successful deal. His other hits include the IPOs of Agile Software, Flextronics and Yahoo, as well as the acquisitions of PayPal (purchased by eBay), YouTube (bought by Google) and Zappos (bought by Amazon).

But his track record isn’t perfect. His most famous duds are eToys and Webvan.

For now, Moritz says, he will serve as chairman of Sequoia.

Moritz wasn’t the only prominent VC to disclose a pared-down role in 2012. New Enterprise Associates co-founder Dick Kramlich was not listed as a general partner the firm’s 14th fund, which closed this past year, and has spoken to colleagues about plans for retirement.

DCM founder Dixon Doll also says he plans to scale back his involvement in upcoming funds, but did not specify an intention to retire.

Newcomer Nearly Tops in Fundraising

Just three years after closing its first $300 million fund, Andreessen Horowitz has already emerged as one of the venture industry’s biggest and most influential players. In January, the Silicon Valley firm closed the second-largest new venture fund of the year, the $1.5 billion Andreessen Horowitz Fund III.

For the remainder of the year, the firm actively put that money to work. It backed new or follow-on rounds for more than 50 portfolio companies in 2012, according to Thomson Reuters, with a particular focus on the cloud computing and online retail spaces. Investments included pinboard photosharing site Pinterest; design-focused online retailer Fab.com; developer hosting site GitHub; and room rental site Airbnb.

JOBS Act Blues

For a U.S. Congress too divided to agree on a deficit reduction plan, the passage of the Jumpstart Our Business Jobs Act, or JOBS Act, marked a rare display of bipartisanship. The act, which Congress passed in March, was heavily supported by the venture industry—and for good reason. VCs have their handprints all over the law. Scale Venture Partners co-founder Kate Mitchell, one of the guests at President Obama’s April JOBS Act signing ceremony, was chairman of the IPO Task Force that drafted the recommendations that went into the legislation.

There’s plenty in there for VCs to like. Among other provisions, the act loosens disclosure and regulatory requirements for IPOs of emerging growth companies (a category that encompasses pretty much all VC-funded startups.) It also creates a framework for crowdfunding new businesses and lifts the ban on general solicitation for private securities transactions.

Yet eight months later, VCs have yet to see much impact from the JOBS Act. One reason is the Securities and Exchange Commission, as of mid-December, had still not issued a rulemaking on how it will enforce the new rules on general solicitation. As for IPOs, it’s difficult to say how many companies have taken advantage of the new rules, as one provision is that initial filings may be done without public disclosure. And companies that did make it to market under the new guidelines, such as real estate website Trulia, would likely have gone public regardless.

Series A Crunch

Actually, we shouldn’t be surprised. A rise of incubators, accelerators and tons of angel investors has given rise to a plethora of nubile early-stage companies that just can’t seem to get a first venture round done to save their life.

Behind the early stage ruckus is a bumper crop of angels. The number of active angel investors topped 300,000 in 2011, up 20% from 2010, according to the University of New Hampshire’s Center for Venture Research. The ranks of the matchmaking service AngelList also swelled, with 2,500 investors joining the community in 2011. When AngelList launched in spring 2010, it listed 80 accredited investors.

UNH also reports 62,000 U.S. companies received angel funding in 2010 and another 57,000 in 2009. The numbers were up from prior years despite the global economic slowdown and may be even larger since some deals are not reported.

The question is how many of these angel-funded startups will survive? The mortality rate is likely to be high.

In addition, we wonder, will this pave the way for some well-known incubators and accelerators to go under in 2013?

Stay tuned. …

Joanna Glasner can be reached at joanna.glasner@thomsonreuters.com. She tweets at @jglasner.