Slowdown puts start-up funds in peril
How do we get our money back?
That question, much on the minds of ordinary investors after a calamitous 2008, is also being posed by venture capitalists, the financial professionals who bankroll innovative start-ups in fields ranging from healthcare to information technology to clean energy.
The "exit" pipeline for venture investors - their ability to recoup and profit on their investments - clogged up substantially last year as global stock markets plunged and economies around the world contracted, according to data released yesterday by the National Venture Capital Association, an Arlington, Va., trade group.
There were no initial public offerings of venture-backed companies nationally in the fourth quarter and only six for the entire year, the smallest number since 1977, the figures showed.
"Right now, we don't have a functioning capital market in terms of young, IPO-able companies," lamented Jean-Francois Formela, partner at venture capital firm Atlas Venture in Waltham. "There is no demand, so you can't really price new securities."
The only other avenue for exits is mergers and acquisitions. And their number slowed to 37 in the three months ended Dec. 31 and to 260 for all of 2008, marking the first time since 2003 that fewer than 300 venture-backed companies were sold in the United States.
Here in Massachusetts, the nation's second-largest venture capital hub, after California's Silicon Valley, the exit numbers were even grimmer. Not a single venture-backed company went public in 2008, and only 20 were sold during the year, according to the figures compiled for the venture group by the Thomson Reuters research house. By contrast, there were 19 state IPOs and 34 acquisitions in 2007.
The data raised the question of how many new entrepreneurial companies would be funded this year as venture firms husband their cash and set up reserves to help them tide over companies already in their portfolios. It also raised the possibility of the venture capital industry shrinking and start-ups being folded or unloaded at fire sale prices in coming years, some venture professionals suggested.
Venture investment totals for the September-to-December period are still being calculated and are scheduled to be released by the venture capital trade group this month.
"The fallout could be that we see less funding of new companies because venture capitalists will be spending so much time with existing companies that they thought would have been sold or gone public by now," warned Mark G. Heesen, president of the venture association. "Many of these companies are going to need another round of late-stage financing."
Todd Hixon, managing partner at New Atlantic Ventures in Cambridge, predicted a consistent but slightly reduced investment pace in 2009 with more emphasis on later-stage deals. But many firms are conserving their cash, fearing it might prove harder to find partners to back start-ups in their portfolios over the next two years, he said.
"There's still a lot of money in the industry, absolutely," Hixon said, noting that venture firms have raised more money than they've invested in recent years. "But we're at the point where a lot of firms aren't going to raise money again. A lot of people feel that a shakeout of venture capital firms is coming." Hixon said the survivors are likely to be established firms with strong performance track records.
Venture capitalist Dennis Miller, general partner at Spark Capital in Boston, said the firms best able to capitalize on new opportunities in this environment might be newer partnerships unencumbered by legacy investments.
Older firms may face a choice between "funding the dogs" in their portfolios or investing in more attractive new ventures, he said.
"The nature of the beast is, only a few of your investments drive your returns," Miller said. "So if you've raised a lot of money over the years, and you're on fund five and you have 122 companies draining the coffers, that's going to be a tough place to be. The triage that's going to happen this year is going to be nasty."
Technology and life-sciences companies that are "strategic acquirers" of venture-fueled start-ups are well aware of the new environment. "What you have out there now are more picky buyers who are biding their time," Heesen said. "You could be seeing some fire sales later this year."
Robert Weisman can be reached at weisman@globe.com. 