By Kim Hart
Washington Post Staff Writer
Tuesday, July 1, 2008
Eight months ago, medical treatment firm Broncus Technologies was ready to sell its stock to the public. The company, which develops treatments for lung diseases, filed the paperwork, talked with major banks and waited for the perfect time to make its debut on the public stock market.
That time never came. The economy turned grim, and the financial markets worsened. So two weeks ago, the firm pulled away from its public offering and is instead searching for more private investment.
"It was clear the market just wasn't going to open up for us in the foreseeable future," said chief executive Cary Cole, who said the Mountain View, Calif., company raised $80 million over the past 10 years. "If things didn't turn around in a very positive way, we just weren't going to go through with it."
For the first time in 30 years, zero venture-backed companies made initial public offerings during the second quarter, according to a report to be released today by the National Venture Capital Association and Thomson Reuters. The drought follows a slow first quarter, when five venture-backed firms went public, and it is a serious downturn from the first half of last year, when 43 companies went public.
Mark Heesen, NVCA president, called the situation a "crisis for the start-up community" and warned that the absence of public offerings would delay the return of investment for venture capitalists, making it more difficult for them to fund other entrepreneurs.
"The more time you have to spend with an existing portfolio company, the less time an investor can spend searching for new opportunities," Heesen said. "Venture-backed companies that successfully enter the public markets represent a critical job-creating engine for the economy, and that engine has completely shut down."
An initial public offering is one major growth strategy for young companies that hope to gain additional funds by selling shares. During the high-flying days of the dot-com boom in the late 1990s, such offerings were common ways for venture-capital-backed start-ups to raise quick cash. But the large amounts of money going to relatively young and untested firms quickly backfired, and the market crashed.
Since then, most young companies have hoped to be acquired by a larger firm rather than take the riskier route of going public, even though entering the public market is generally seen as a more lucrative way for venture capital investors to recoup their funds. The introduction of tougher accounting rules also dissuaded companies from going public.
Poor economic conditions have slowed the rate of mergers and acquisitions, the report shows, as larger companies are forced to reduce spending.
"We will have to allocate our capital more carefully," said Hooks Johnston, general partner of Valhalla Partners in Vienna. "It could force us to cut off funding to weaker companies."
Several of the firm's portfolio companies have delayed their plans to go public by as long as 18 months, he said. "We have to support them longer," Johnston said.
The time it takes for a company to be mature enough for an initial public offering is also growing. It now takes a company about 8.6 years after its first investment to successfully go public, up from four years in 1999, according to the report.
A survey of 662 venture capital investors showed that 91 percent of investors view the lack of initial public offerings as "critical" to the future health of the venture capital and entrepreneurial communities. Most investors attribute the drought to skittish investors and the widespread shortage of money for borrowing. Seventy-five percent of investors don't expect to see successful public offerings during the next year or two, while 5 percent expect the drought to last longer than two years.
At Core Capital Partners, a venture capital firm in the District, some start-ups are opting to merge with other promising companies with plans of going public once the economy improves, said managing director Mark Levine.
Some start-ups are raising new rounds of financing large enough to sustain them until the market looks brighter. For instance, San Francisco-based Yelp this year raised $15 million in funding in part because of the weak economy.
But start-ups will most likely hire fewer people as they try to conserve cash, which could have negative repercussions on the job market, said Don Rainey, general partner of GroTech Ventures in Vienna.
"If a 14-person company doesn't hire an additional three people, it won't really be noticed. But if a million small companies stop hiring, that will have ripple effects," he said.
There may be an upside, however, to the lack of large public offerings, said Jonathan Aberman, managing director of McLean-based Amplifier Ventures. Because it takes longer to recoup their large investments in a company, venture capitalists may opt to put smaller sums toward younger companies, creating more opportunities for entrepreneurs.
"A lot of people are feeling the pressure right now to start thinking about better ways of recycling capital," Aberman said. "But it's not a permanent problem; it's a cyclical problem."