Annual VC Meeting Comes to Boston, Early Talk Centers on How to End the IPO Drought

4/29/09

Initial public offering activity among venture-backed companies has fallen off a cliff. That’s a top problem facing the venture capital industry right now, and, as can be imagined, the hot topic of discussion in the early hours today at the National Venture Capital Association’s (NVCA) Annual Meeting in Boston. The mood here at the Westin Boston Waterfront Hotel can be summed up by the comment of one member of the venture community to his counterpart near the registration desk: “These are certainly interesting times.”

Indeed, the venture industry is, to say the least, struggling. A chief concern is that the steep drop in IPOs—not only in the past year, but over the past decade—has forced venture firms to hold onto their shares of private portfolio companies longer than they would like. So the day here began with a press conference where the VC honchos (including new incoming NVCA chairman Terry McGuire, managing general partner at Waltham, MA-based Polaris Venture Partners, and Paul Maeder, general partner at Highland Capital Partners in Lexington, MA,) and others discussed their recommendations on how to improve the climate for venture-backed companies to go public. Before this month—when San Diego-based online education firm Bridgepoint Education, Chinese gaming company ChangYou, and language education software provider Rosetta Stone of Arlington, VA, all completed IPOs—there hadn’t been a single venture-backed company IPO for eight straight months.

For sure, venture firms can also get big returns on investing in companies when those companies are acquired. In fact, last year 87 percent of venture exits were via a merger or acquisition, according to the NVCA. Yet to hear Dixon Doll, outgoing chairman of the NVCA, the concern is that only 13 percent of venture exits last year stemmed from company IPOs. “The question that always comes up is that if you have a thriving M&A environment, why isn’t that good enough to have a flourishing VC industry,” said Doll, who is also a general partner at Menlo Park, CA-based venture firm DCM. “In order to have really successful M&A exits, the M&A buyers have to know that the company really can go public, or much of the leverage is lost and the value creation that we’re so concerned about is stifled.”

Thus, the NVCA is offering four main areas in need of change in order to improve IPO activity. Here they are:

—Improve the IPO ecosystem. This one involves broadening the choices of investment banks and accounting firms venture-backed companies can choose to work with to complete maiden public offerings. Part of the thinking here is that venture-backed companies have a dwindling number of options of such partners right now, and that there is a need to find alternative investment banks and accountants that might better understand the needs of emerging growth companies. Also, some of the smaller banking firms might provide analyst coverage of these typically small-cap companies after an IPO—something large investment banks may not—providing potential investors with ongoing information to help them make decisions about buying the stock of such companies. It can help maintain or even increase the value of a stock when there is continued interest in buying it, and having a strong stock value is important to helping small companies raise more money and grow.

—Boost liquidity events. An idea here is that investment banks need to find buyers for venture-backed company IPOs who are committed to holding onto a firm’s stock for several years, allowing the companies to achieve milestones without fear of rapid trading that can drive down their market value. These cherished buy-and-hold investors are tough to come by in an investment environment rife with hedge funds that often trade stocks heavily to boost returns. Another strategy offered to enhance liquidity in venture portfolios is to merge similar portfolio companies to make them more qualified to complete IPOs. Highland’s Maeder weighed in on this strategy, saying that the lack of venture-backed company IPOs has left industries with too few corporate consolidators.

—Tax incentives. Here, the venture community is asking for a bit of help from the U.S. government to make IPOs for their portfolio companies more enticing. (NVCA president Mark Heesen says, though, that his association is not asking for a government bailout). The tax code can be a bear for smallish, venture-backed companies and their investors. One idea is to maintain the capital gains tax rate, or even to make tax requirements more generous for investors who hold onto stocks in newly public companies for several years. Heesen says that the capital gains, meaning the profit on stock sales, are a key reward for entrepreneurs that drives company formation and so keeping the post-IPO taxes low on such gains is a potentially valuable incentive for investment.

— Review regulations. An idea to mend regulatory conditions was to make the internal controls provisions in Sarbanes-Oxley less onerous and costly for small-cap companies. In some cases, the high costs of complying with this portion of Sarbanes-Oxley can be prohibitively expensive, causing venture-backed startups to seek alternatives to going public.

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