Why VCs Are Striking Out

The Q2 goose egg for VC-backed IPOs has every pundit and prognosticator coming out of the woodwork to weigh in on what’s “really” going on.

The NVCA polled VCs and found investors attributing the whiff to a variety of short-term shocks such as the credit crunch and Sarbanes-Oxley.

But the story of an increasingly anemic IPO market goes back more than a decade. In 1992, a VC might expect as much as 65% of his or her exits to be via IPO. That number fell steadily to 10% by 2005 and has continued to fall since.

The VC industry is laboring under a set of outdated assumptions, a structure optimized for conditions no longer applicable and an unwillingness or inability to embrace the tectonic change it is undergoing. The hand wringing about various short term shocks (such as skittish investors) that sunk the second quarter’s IPOs misses any serious discussion of the long-term systemic shifts that many VCs have failed to act on.
I offer five forces that underly the observable change in modern venture capital:

  • The technology industry has matured to the extent that startups are viewed as outsourced R&D by big companies.
  • The consolidation of technology verticals via either winner-take-all competition or multi-billion dollar acquisitions has decreased the number of would-be customers and acquirers for focused technology offerings.
  • The over-availability of growth capital promotes competition among startups for scarce resources such as technical employees and early-adopter customers and raises development costs accordingly.
  • Attractive investments may be increasingly found through creative deal sourcing and structuring rather than sexy technologies, big markets or “hot” entrepreneurs. Similarly for successful exits.
  • Successful firms have formalized their succession planning to preserve their virtuous cycle, making specialization an increasingly attractive strategy for first time funds.

What else goes on this list?


  • This is great list. I would add the following:

    * The weakness of patent rights and shortage of patent lawyers prevents IP-driven partnerships from being a more viable alternative to venture-backed growth followed by M&A.

    * Weakness in the credit market (for U.S. M&A), the expense of SOX compliance (for U.S. IPOs), and the marketing difficulties with listing abroad (for IPOs in London or Hong Kong) for U.S. based companies.

  • Some other points to note:
    -Many companies seem to get finance, and a lot of it, for the wrong reason. Take Akimbo for example. The old mantra of eyeballs and other irrelevant stats do not work anymore.Cash flow and profits are all important. I was astounded at Arianna Huffington’s comment on CNBC’s Business Nation that she has no interest in making a profit, just getting distribution.
    -A lot of VC employee’s have never run a business or met a payroll so are over diligencing and incorrectly analysing business models and hence many outstanding companies miss out but would probably be better investments.
    -Seems like PE/VC community may have become a little to slow and provide finance and then on some onerous terms making it difficult to exit.
    -Professional fee’s are killing a lot of these smaller companies as well due to over regulation and risk aversion. It is time to take bigger risks again which is what made this country great.

  • I agree with Martin. My company VC Experts.com is getting alot of the runoff from entrepreneurs not willing to pay their houses for professional service providers. Then again, the PSP’s are cutting staff, costs and will soon be at price wars with the competition.

  • There’s two sides of it… the VCs, and the people buying the stock in the IPOs. How much of this is reduced public market investor demand for the companies that VCs back? If that’s the brunt of it, then VCs truly have something to fear. Yet I wonder, how much of the drop in IPOs as a % of exits is simply an artifact of trends in the VC industry over time? For example, it’s theoretically possible for the number to fall to below 10% from 65% simply because the overall number of exits increased due to more M&A and sponsor to sponsor exits, while IPOs stayed flat. When you combine the two sides of the matter, more relationships come to light… for example if the markets can only back so many vc-backed IPO’s a year, yet the number of VC backed companies has grown substantially, then the trend is to be expected. Sadly, I don’t have the numbers or the experience to know what’s going on.

    What I’ve said is news to nobody, but it helps to think of the relationship between public markets demand, an almost exogenous variable, and the # of VC backed companies, as determined by activity within the VC industry.

  • After checking out the links some of my questions have been answered. The # of M&A exits went up AND # of IPO’s is down.

    It’s only natural if the public markets want less of that dish right now. In the 90’s there were many easy opportunities to pursue, and the profits were unimaginable. Nowadays people have a good idea of what a company is capable earning if it does succeed, and most of the low hanging fruit are gone. Look at Apple & co… in many instances it’s costing people a LOT of money to take things to the next level. In the 90’s all you had to do was sell a brick of a mobile phone (not to undermine some of the tremendous things VC accomplished in that period)… now look at what a phone has to have to move the market. There will be another wave around the end of the decade, perhaps sooner than that for web. Fundamental changes have already occurred in the web, are in progress in HCLS, and will come eventually to hardware/telecom. We just need those herculean feats that change the playing field, and then everybody will have a better shot.

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