I'm at the AlwaysOn Stanford Summit reporting for Read/WriteWeb. This afternoon there was an interesting presentation about the state of the venture capital market. Specifically, it started with a presentation by Paul Denninger, Vice Chairman of Jefferies & Co, entitled "Why Aren't VCs Happy?" and then Paul joined a panel moderated by Mark Stevens, a Managing Partner of Fenwick & West. Other panelists included Roger McNamee, a Partner at Elevation Partners (probably most famous because of their association with Bono of U2), Erik Straser, a General Partner at Mohr Davidow Ventures, and Bill Gurley a General Partner at Benchmark Capital.
I've attended a number of presentations and panels at industry events over the last six months on the state of the venture capital market. In addition, there seems to be a recurring meme in the blogosphere on the subject. To be honest, each of these panels - while interesting - seem to raise the same issues every time. They focus on how inexpensive it is to start and reach critical mass for consumer web services. Thankfully then, this panel today actually took a very different path. Paul laid out a number of interesting statistics around options for exits. It leads to some interesting questions that entrepreneurs need to evaluate.
Paul started by stating, "Despite the topic of my talk, I think that VCs are happy. But I believe they maybe shouldn't be." He then focused on a number of 'facts' and contrasted them with some common 'myths'.
The Technology M&A Market
The first myth he discussed was that the M&A market is back and going strong. Instead he argued that the technology M&A market is actually well below historical averages. He said that people are usually surprised by this, because there are some big deals going on nowadays and they are in the news. However, the fact is that most of the large (greater than $50M) exits have been to Private Equity firms. He explained that this time last year, there was a total of $40B private debt financing around companies that were looking to eventually exit to public capital markets. Today, there is $230 billion of private financing around private equity backed companies.
As if that reality wasn't grim enough, he also emphasized that the deals that are being done by public technology firms are actually being sold to a very small group of companies. Specifically, he explained that 35% of of all tech deals greater than $100 M were done by 10 companies, with a total market cap of $100 B.
The IPO Market
The other myth that Paul focused on was that "the IPO market is back". He said the fact is that before the bubble, in the early nineties the public markets had about 130 IPOs per year. This year, Paul believes we'll probably do fifty or sixty. He explained the reason it feels like 'the market is back' is because we went through a period of doing twenty-five or thirty a year.
Q.E.D.
So according to Paul, most VCs have been funding companies that are "reliant on the M&A market." He said it was 90% of VC liquidity last year. The increased focus on M&A has also meant a decrease in each of the last 6 years of the number of public tech companies. For context, before this streak of consistent declines you need to go back to 1988 or 1989 for when there were 2 straight years.
Right up to this point, everything Paul had laid out was consistent with things I'd heard before; but complimented by strong statistics. However, right then he delivered an interesting point about the future of the market.
Hypothetical Question: The Cisco Market Cap at the time of its IPO was $225M. Today, he asked would Sequoia Capital or other VCs have taken Cisco public, or would they have tried to shop it to AT&T for $250M? The data shared with us seems to lead to the belief that they would have tried to find an acquirer. The challenge is: would Cisco have created the value in the tech market and for other entrepreneurs if they had simply been acquired?
At this point, the rest of the panel entered to discuss if they were indeed happy! After everyone introduced themselves, Roger McNamee said:
"Can I push back on what Paul just said? I've seen all the statistics he saw and I agree with the data. However, I think it doesn't matter, because predicting the future is fairly futile."
However, he continued by noting that "in the battle between fear and greed, fear is temporary but greed is permanent." Therefore, if there is money to be made, then Wall Street will pull those companies to the public markets out of greed.
Bill Gurley said that he actually felt like this was a fairly liquid time. But if he had one concern it would be "the lack of desire of executives to run these public companies." He explained that the average expense to become Sarbanes Oxley compliant was $2.5 million. He told a few good auditor jokes, but also continued to reiterate the concern around identifying executives who want to step into those roles.
While the panel was looking at this from the perspective of a venture capitalist, it did raise some interesting issues as an entrepreneur. What kind of company is each of us trying to build? Obviously, we each need to ultimately make sure we're creating value for our shareholders.
However, this panel showed a very different perspective - that maybe we're focusing too much on being acquired by a limited set of companies. What do you think?
Comments
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Who ever wants to be a serial entrepreneur with the goal of being associated with as many startups as possible, this is the right time.
But then again even considering the idea of taking public, how many of today's entrepreneur's have the ability to play a lead role after the IPO stage and how many investors would prefer the same founder to lead even after the IPO?
Posted by: Evangelist | August 1, 2007 11:38 PMI totally 100% agree. Everyone is looking at the same 6 or 7 companies. It is ridiculous, and makes it that much more likely that the internet will someday be some sort of crazy Oligopoly, totally dominated by a small group of companies.
This is a regulatory thing though. SOX destroyed the IPO market. The ONLY way this is going to change is either 1) they dramatically change SOX or 2) it becomes very acceptable to do public offerings on AIM or on the Toronto exchange (TSX).
The whole world run by a few powerful companies/conglomerates is bad for everyone. But for most companies it is the only possible exit. And since everyone must be funded to succeed, all investors are going to require an exit. This basically dooms us to this system, unless one of those two changes occurs (which is not likely).
My 2 cents.
Posted by: Tim McCormack | August 2, 2007 12:02 AMLinks to Webcasts of Deninger...
http://alwayson.goingon.com/page/display/15568?param=session/101
and the panel...
http://alwayson.goingon.com/page/display/15568?param=session/103
I'd be interested to see who those 10 companies he mentioned were who were doing most of the M&A.
Posted by: Paul Montgomery | August 2, 2007 12:08 AMHey Sean,
Great post and I agree 100% as well. Getting acquired is web 2.0's revenue model, as nearly all new services launch as a free model to facilitate widespread adoption and streamline the path to critical mass. Start-ups are simply too reliant on the M&A market.
I wrote a very similar post, outlining my thoughts. You can read it here:
http://www.mappingtheweb.com/2007/05/28/everyones-web-20-revenue-model/
Let me know your thoughts...
Cheers,
Posted by: Aidan Henry | August 2, 2007 12:57 AMAidan
I'm going to have to agree with what the guys above me posted. The business model that most Web2.0 companies are using can only work for so long before some real funding is needed, at which point you can hear the collective "Please acquire us" from miles away.
Posted by: Justin Smith | August 2, 2007 2:37 AMSOX costs have become a lame excuse for the lack of interest in the investing public to take on the risk of a pre-profit IPO (note: I am an accountant). Far greater attention should be spent on creating businesses with technology worth exploiting broadly and less on incremental features to be bought (in agreement with Aidan and Justin).
Posted by: CoryS | August 2, 2007 5:31 AMTo CoryS - Why should the public want to take on the risk of a Pre-Profit company?
For an accountant that is a surprising comment. Almost no companies that go public are pre-profit. That mostly happened during the hey-day of the bubble. It was a mistake then, and it still is today.
Maybe you think differently as an accountant, but VC's are looking for specific multiples when judging investments, in reference to their return on investment. For a company to make it to the stage where they can truly afford $2.5 million in SOX, along with all the new annual obligations & restrictions, it simply must be larger.
That takes more time, and more risk. It also makes it harder to justify the investment. These funds have limits on how many years they can wait to pay out their principles. And these funds really control the company. So funds will sell a company because they don't want to wait another two or more years - especially with the uncertainty of how long they will wait.
I know accountants love SOX. It is like permanent job security. Also naive portions of the public loves SOX, because they think it makes them safer. Most people who actually know what they are talking about do not love SOX, and recognize that it has had a dramatic impact on our IPO market, creating a strategic disadvantage for the US. Too much regulation with too little benefit. SOX sucks.
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Posted by: www.hello-luxury.com | August 2, 2007 9:15 AMGreat post. I wrote a similar one with a slightly tongue-in-cheek title Venture Capital as Charity? (http://livinginfirstlife.wordpress.com/2007/07/27/venture-capital-as-a-charity/)
Posted by: TechDumpster (Living in First Life) | August 2, 2007 1:58 PMI can understand how a $2.5M 'unnecessary' SOX expense has held back some great companies from going public. For those that are concerned that this isn't going to change, I have good news for you. They are implementing new standards that's going to greatly reduce the cost of being compliant.
On a side note, everyone likes to blame the accountants for the exorbitant compliance fees. Take a look at the rules and try to interpret them for yourself. Then ask yourself if you would be willing to risk going to prison for not getting it right.
Posted by: Nikunj | August 2, 2007 8:07 PMAren't rules governing IPOs and such a good balance to the abuses that occured in the not-so-distant past? I know SOX costs money to implement, but the public, who IPOs rely on to fund their companies, need to know that there are no more than 4 aces in the deck and the roulette wheel isn't rigged to always win on black. http://www.innovators-network.org is a non-profit with the aim of helping small businesses, entrepreneurs, innovators, and venture capitalists gain from interaction with technology. Visit us to find out more and thank you for the interesting post, Sean.
Posted by: Anthony Kuhn | August 3, 2007 4:45 PM