For start-up investors, no way out

Venture capital firms increase later-stage outlays as they wait for 'exit' opportunities to arise

(Wendy Maeda / Globe Staff Photo) Concept artist Tara Rueping works on an Internet game at Turbine, Inc. The firm secured $41.7 million in the April-June quarter.

They are a little like college graduates whose parents want them married or out in the workforce on their own. Instead, they've come home to hit up mom and dad for more money to go to grad school.

Welcome to the venture-backed start-up world in the summer of 2008, when the prospects for cutting the cord look mighty daunting. If this was an existential play, it might be called "No Exit."

The window for initial public offerings is closed tighter than at any time since the 1970s.

Technology and life sciences companies are fetching smaller sums from buyers.

And venture capital firms, which typically seek to cash out investments with handsome profits in five to seven years, find themselves ponying up more money to tide over their portfolio companies until "exit" opportunities arise.

Making the analogy to anxious parents and late-blooming children, John S. Taylor, vice president of research at the National Venture Capital Association, said the message from this year's college grads is "the job market isn't good, graduation is overrated, and they're going to stay around" campus longer. "So we have a lot of companies now in this later stage that require financing."

There were a record 318 late-stage venture financing deals in the second quarter, totaling about $3.1 billion, nearly half the capital invested in all start-ups nationally in the three months ended June 30, according to data from the quarterly MoneyTree report. The report is compiled by the Thomson Reuters research house for the venture capital trade group and the accounting firm PricewaterhouseCoopers.

The increasing number of outlays to more mature start-ups - companies that in the past might have already gone public or been snapped up by technology or life sciences buyers - suggested venture investors are diverting time and resources from the task for which they are best known: bankrolling risky early-stage companies, the lifeblood of high-tech hubs like Greater Boston and California's Silicon Valley.

"When you've got a certain number of portfolio companies, it puts a strain on the amount of time you can put into new seeds," admitted Trevor Loy, managing partner at Flywheel Ventures, a Santa Fe venture firm that backs start-ups in the Southwest.

Here in New England, the number two magnet for venture capital, after Silicon Valley, nine out of the 10 largest funding deals in the April-to-June period went to later-stage companies, MoneyTree data showed. They included the region's three biggest funding rounds in the quarter: $50 million to clean energy start-up Powerspan Corp., of Portsmouth, N.H.; $41.8 million to biotech start-up Gloucester Pharmaceuticals Inc., of Cambridge; and $41.7 million to the massively multiplayer Internet game maker Turbine Inc., of Westwood.

At Turbine, a 14-year-old company that calls itself Hollywood on the Charles - even though it's based near Route 128 - there's no sense of panic about the diminishing outlook for venture exits. The company produces such popular online games as Asheron's Call, Lord of the Rings, and Dungeons & Dragons. It will use its new cash to expand globally, continue building out its Internet "worlds," extend delivery platforms from computers to game consoles, and roll out technology enabling users to create features within games, said Jim Crowley, who took over last fall as chief executive.

"We're the only company out there that's created three Triple-A online worlds on a global basis," Crowley said. "We think Turbine is uniquely situated to hit the ball out of the park."

While the company is well into its second decade, long in the tooth for a venture-backed enterprise, Crowley said it is only five years into a strategic shift from a game development shop for other companies to an operator of gaming worlds in its own right.

"I feel like we control our own destiny," he said. "Our job right now is to grow our content and our revenue base around the globe, and that's what we're going to do. I see us as a $1 billion company [in annual sales], and whether we're going to be a public company or whether we're going to be acquired, I can't answer right now."

But in the short term, the prospects for "liquidity" - when venture capitalists and their limited partners, such as pension funds and endowments, recoup their investments at a profit - are less promising than they have been in years. As the national economy weakened, there were no IPOs in the second quarter, and only five in the first quarter, according to figures from Thomson Reuters.

The median acquisition price for venture-backed start-ups, meanwhile, tumbled to $63 million in the first half of 2008, from $93 million in 2007, according to data from Dow Jones Financial Information Services. The median price had been climbing steadily since 2002.

With the number of acquisitions of venture-funded US companies also slipping - there were 142 in the first six months of this year, down from 203 in the same period last year - valuations may fall further in coming months, some venture investors fear.

"The only way you make money in venture is when you exit," said Michael Travaglini, executive director of the Pension Reserves Investment Management Board, which invests the Massachusetts state employees pension fund in a range of asset classes, including venture capital.

"Clearly you're going to see some short-term dilution in returns," he said. "But as a pension fund, we have a long-term investment horizon."

Robert Weisman can be reached at weisman@globe.com.