Is the Venture Model Really Broken?
Proclaiming the venture model broken is in vogue. The lingering aftereffects of the Internet bubble have cast a shadow over the industry for a decade now; and while venture capital has consistently outperformed most equity asset classes for years, recent returns have not lived up to historical norms. Despite the grim headlines, there are signs of success all around us that prove that the venture model is far from broken.
Venture capital is, at its core, about helping to build innovative, high-growth, market leading businesses. The easiest way to measure success is to look at the exit market for venture-backed companies.
A sampling of transactions since September of 2009 in Massachusetts alone:
• Quattro Wireless was acquired by Apple for $275M
• Gomez was acquired by Compuware for $295M
• Nova Analytics was acquired by ITT for $392M
• E Ink was acquired by Prime View International for $400M
• Gloucester Pharmaceuticals was acquired by Celgene for $640M
• Ironwood Pharmaceuticals had a post-IPO market cap of $1.1B
• A123Systems had a post-IPO market cap of $1.3B
With all of this exit activity and value creation, it’s hard to understand why industry returns have lagged in recent years. The underlying data gives a good sense of the dynamics. The insights below are based on data from Thomson ONE.
There are some clear positive signals:
1. Exit volume is healthy. The IPO market has functioned on an intermittent basis in recent years, but M&A volume for venture-backed companies has taken up the slack and become the predominant exit path. When combining M&A and IPO exits, the activity has actually been fairly consistent over the years: about 300-500 per year since the mid-’90s.
2. Acquisition valuations are healthy. The average reported acquisition value for a venture-backed company hovered around $60M in the mid to late ’90s, and (after a spike in 1999 and 2000) has been averaging far more than $100M in the last few years, including 2009. Pre-IPO valuations for venture-backed companies have similarly increased over the years from around $150M in the mid ’90s to around $400M in the last few years. The increase in average exit valuations confirms that substantial equity value can be created within successful venture-backed companies.
There are negative signals too, of course, including:
1. Too many companies backed. The substantial increase in the number of companies receiving venture funding has created a glut of companies seeking an exit. In the early ’90s, there were about 1,000 companies backed by venture capital firms each year in the U.S. The late ’90s brought a rapid increase in investment activity that peaked at … Next Page »