Out of the Abyss: M&A and IPOs Restart the Innovation Flywheel
Only six weeks ago, many of us were wringing our hands about America’s faltering innovation engine. Investments in VC-backed startups had been plummeting for more than a year and American corporations had been slashing internal longer-term R&D spending for decades. Even the federal government has been investing markedly less on basic science and technical research as a percentage of total economic output.
What a stunning difference 42 days make. Mergers and acquisitions in both the startup and Wall Street worlds have spiked sharply, and the IPO market is showing signs of life. These developments hardly solve the U.S. innovation crisis overnight. They do however serve to re-start the innovation flywheel and strongly suggest that the long-beleaguered venture capital industry is poised to rebound and eventually spark the rebuilding of critically important innovation muscle in other sectors of the economy.
Am I being too bullish? Based on more than two decades of experience in the seed and early stage venture capital with recent exits of $2.2 Billion from M&A transactions, I don’t think so.
Startup “exits” – whether they are M&A or public offerings — are ultimately the lifeblood of venture capital because they allow investors to monetize their past investments and invest in a fresh round of startups. And this leads to a virtuous cycle. Corporations, which have cut back significantly on innovation and venture investing in recent years, begin realizing anew that the markets in which they compete continue to march forward. Sitting on the sidelines if not a viable option and increasingly, they are turning to the venture-backed domain of start-up innovation as an invaluable external R&D arm. Given that major corporations have cur their R & D investments in half over the past 30 years in parallel with the 4X explosion of innovation investment by small companies, we are no doubt standing on the precipice of permanent increase in strategic M & A activity as open innovation continues to take hold.
Here is a quick glance at what has been happening lately. In the venture capital world, Facebook acquired startup FriendFeed in mid-August for a reported $47.5 million. The same week, VMware snapped up SpringSource for $420 million. Shortly thereafter, Intuit announced its $170 million acquisition of Mint.com, a personal finance site. Its lead investor, First Round Capital, said the Mint.com exit generated the highest return of any deal the firm has done. Also in September, Google’s Eric Schmidt announced his plans to acquire one company per month.
On Wall Street, this week alone Xerox announced it would buy Affiliated Computer Services and Abbott Laboratories said it would buy the drug business of Solvay. Last week, Dell acquired Perot Systems. A week before that, Adobe Systems turned heads with the announcement that it planned to buy Internet services firm Omniture for $1.8 billion, its biggest acquisition since the blockbuster purchase of Macromedia Inc. in 2005.
I’m hardly the only one impressed by this activity. Wall Street bankers are saying that the sudden increase in corporate mergers shows a new sense of confidence. “The psychology has changed,” Boon Sim, head of mergers and acquisitions for the Americas at Credit Suisse, told The New York Times in late September. “This is a sign that things have stabilized.”
In addition, the IPO market is re-energizing. Last week, seven companies went public, including electric-car battery maker A123 Systems Inc., marking the biggest week for IPOs since March 2008. Another bright sign is that this year’s few big IPOs have seen their stocks hold well above their IPO prices. This makes venture capitalists more inclined to test the waters and take a startup public. Venture capital-backed OpenTable Inc., for example, is up more than 35 percent from its offering price.
More Silicon Valley IPOs are on the way – assuming markets remain stable. Fortinet, a Sunnyvale computer security firm, and Mirion Technologies, a San Ramon maker of radiation-detection devices, recently joined a growing flurry of pending deals – and the line is growing.
Overall, what both the M&A and public markets are saying is that innovation does not stand still in technology-driven markets. Companies that want to stay competitive must become more aggressive about innovation and growth. Strategic M&A activity, in particular, signals the beginning of a product replenishment cycle.
There is no question that the stage was set for this rebound in activity. Merger and acquisition activity in the VC world and on Wall Street had hit bottom. The value of VC-related M&A tech deals announced in the first half of 2009 was about $58 billion, the lowest level in five years, according to Thomson Reuters. The story was the same with IPOs. In the first half of the year, only six VC-backed companies went public, not much better than 2008, among the worst years on the books. Whether an acquisition or an IPO, a path to liquidity is the essential grease for the venture wheels of innovation.
Just as we saw during the dot-com bust, widespread reports of the death of innovation and the venture capital ecosystem were pre-mature. As with all industries, venture capital is undergoing changes. With increased reliance on M & A exits, at least in the near term, venture managers will be well served to revisit their investment models and adjust their strategies accordingly. And while the market for IPOs regains its footing, successful M & A candidates are likely to play an increasingly important role in the path to liquidity for venture-backed companies.
Robert R. Ackerman, Jr. is the founder and managing director of Allegis Capital (www.allegiscapital.com), a seed and early-stage venture firm headquartered in Palo Alto. Ackerman has worked with more than 50 corporate investment partners over the past 20 years as both a venture capitalist and a startup executive.
Related posts:
Georges van Hoegaerden said on October 1, 2009
Hmmm…let’s see 790 something investment firms, times 1.2 funds per firm, times 10 investments per fund, you call the current returns a recovery of venture capital? What planet do you live on?
Lauren said on October 1, 2009
There’s more to the story. http://www.newsy.com/videos/american_stocks_bucking_the_trend
Bob Ackerman said on October 2, 2009
George –
Last question first… Planet Earth:) A recovery starts with small steps – and these are admittedly tentative. But that said, the M & A market is beginning to come out of its deep freeze. This is partially driven – in my opinion – by an on-going shift in the relationship between large established technology companies (the “Brands”) and the young entrepreneurial start-ups. Bottom line – the Brands need to acquire from the entrepreneurial innovators. They have slashed their own R & D budgets and the products cupboards are bare – in many cases. This cycle has repeated itself through each of the past four recessions – with growing vigor. Frankly, for most major corporations – it is often easier and more efficient to acquire innovation that to create it in-house. I’m not saying that we are returning to 1999-2000 (that was not real) but rather that the pent up demand for innovation is making itself felt through some early, initial moves. If the public markets remain stable – watch this trend to continue and grow. There are quite a few young technology companies out there that can be accretive day one for a major technology Brand.
Bob Ackerman said on October 2, 2009
Lauren -
I like your reference on the markets. Not all M & A transactions are the equal. In the venture world – the transactions tend to be strategically driven and are less dependent upon the availability of credit. There are, of course, other markets which are very much tied to the availability of debt. But for technology companies – the main influences tend to be 1) confidence of underlying economic demand and market stability, and) the need for growth in the form of new products, services and innovation. Reference back to my comment on corporations slashing their R 7 D budgets over the past 30 years – something needs to fill the product/innovation gap. What was once developed at Bell Labs or Xerox Parc is not created by start-ups in Silicon Valley. Rather than fund their own labs for 100% of their innovation, major corporations are acquiring that innovation from start-ups. I would expect to see more of this going forward as competitive pressures continue to mount and the pace of innovation accelerates. On a NET NET basis.. I think we will see M & A by major corporations representing an increasing larger percentage of exits for the venture-backed community.
Georges van Hoegaerden said on October 3, 2009
Bob, I agree the supply of innovation by entrepreneurs is unwavering. But in the investment equation between the assets of the LP (money) and the assets of the entrepreneur (idea) the VC as the intermediary is doing a poor job of arbitrating the application of money.
That has nothing to do with the economy, it led to a descent down the subprime spiral that is the result of a systemically incorrect application of risk to the investment category. VC today is micro-PE, not Venture Capital what is used to be 20 years back. It is the improper risk/reward model applied to the venture model. That has generated a futile influx of utilities rather than companies, to which no private or public market will ever have an appetite.
But there is a solution to this problem, read between the lines of my blog.
Best,
Georges
Bob Ackerman said on October 3, 2009
Georges -
Read your blog and found we agree on quite a few points. As a serial entrepreneur, I started a venture firm 15 years ago out of frustration with venture and belief that the train was coming off the tracks. Increasingly large pools of capital managed by venture capitalists with too little experience in terms of true innovation and risk management – wrapped in a herd mentality. The failure of many in our industry to meet the expectations for returns that they themselves set is an opportunity for all of us to step back and take a look at the model. One of my lead investors describes our firm as “an old fashioned venture capital firm – building companies”. I’ll take it. By following these principals, we have been able to consistently generate returns through some of the most challenging periods for our industry – and we did not do it by following the herd.
I’ll be reading your blog regularly.
Bob
virus extension said on January 16, 2011
I totally agree with this post. you have just made me to bookmark this article
Dong Birton said on January 19, 2011
I am very thankful to this topic because it really gives useful information ,-~