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ANALYSIS
March 2, 2009
Sagging Index no longer reflects what’s going on in the market, some say, Replacements? Google it, to start.
March 2, 2009
Downward price spiral will actually boost the cost of capital for most companies. CFOS, take note.
March 2, 2009
The latest bailout at AIG could be a preview of how the president will deal with Wall Street.
March 2, 2009
No corporate defaults. Big debt offerings. Percolating CP issuance. Things may be looking up in the capital markets.
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December 7, 2008 12:01 AM ET
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“Government leaders in D.C. have to deal with the crisis that is in front of them. We understand this. But what if the crisis that is behind you is even worse?” asked Peter Rosenblum, a partner with the Boston-based law firm Foley Hoag, which has counseled venture capital investors and start-ups since the 1940s. The potential crisis to which Mr. Rosenblum is alluding is the withering on the vine of the nation’s youngest and most innovative companies. Venture capital-backed start-ups in the software, hardware, clean tech and life sciences industries have kept the nation on the cutting edge of economic competitiveness for decades. But the pace and size of venture financings, as well as the market for venture capital exit strategies, are already significantly off the level of a year ago. The argument being advanced by Mr. Rosenblum and many others is that this deficiency will only grow worse if policymakers continue to focus their attention, and Treasury capital, on short-term “stabilization plans” for old-guard behemoths at the expense of longer-term planning to accommodate the more innovative base of the nation’s economic pyramid. Mark Heesen, president of the National Venture Capital Association, is concerned about what the current recovery policies will mean for the state of federal coffers and the capacity for investments in innovation, along with the subsequent commercialization of new technology. “People forget that the VC industry doesn’t do basic R&D,” Mr. Heesen said. “The government is the province of basic R&D. We take what comes out of federal labs and universities, and we apply that research. Now if, because the government has chosen to bail out auto companies and banks, it then starts to cut back on basic R&D at the National Institutes of Health, and the Department of Energy and DARPA [the Defense Advanced Research Projects Agency], then where are we?” According to Dow Jones VentureSource, venture capital deals in the first three quarters of this year lagged behind 2007, with just 1,916 venture financings worth $22 billion completed between January and October. (Some 2,082 deals, worth $23 billion, were done in the same period in 2007.) Worse, according to an Oct. 1 report from NVCA, the market for initial public offerings of venture-backed start-ups, weak for years, has finally hit rock bottom: Over the first nine months of 2008, just six venture-backed start-ups made their debut on stock exchanges—with only one company coming out in the third quarter. It is the lowest volume of public offerings for the nation since 1977. The point, according to Mr. Rosenblum, is that for every billion dollars that goes into a bailout of AIG, Citigroup or General Motors, other critical areas of the credit and lending markets are deprived of capital. Under such conditions, the potential for mergers, acquisitions and IPOs of start-ups only grows weaker. Without a market for such exits, the flow of early-stage venture financings will also continue to dry up, because VCs cannot put their limited partners’ capital at risk without at least a predictable chance of generating a return on the horizon. “With a trillion-dollar budget deficit coming up, there are going to be some very hard choices made by this new administration. Should we be spending $700 billion on bailouts, and should that be done on the back of innovation? That’s a policy question that has to be addressed, and it hasn’t been,” said Mr. Heesen. The financial deprivation of the “innovation economy” in the years ahead would be far more catastrophic for the nation than if GM were allowed to fail, argued Juan Enriquez, the CEO of Biotechonomy, a life sciences investment firm, and founding director of the Harvard Business School Life Sciences Project. “What scares the living daylights out of me is that we’re going to keep General Motors alive at the cost of keeping all of our small, innovative companies alive, and why? The Fortune 500 have generated negative new jobs for the last two years. You have about 0.2% of GDP invested in venture capital today, but almost 18% of GDP comes from companies that were venture-backed.” (His examples, in no particular order, include Intel, Microsoft, Apple, Home Depot, Genentech, eBay and Google.) What’s more, Mr. Enriquez said, nearly all of the growth in jobs has come from start-ups. Using venture capital, it costs about $28,000 to produce a new job, Mr. Enriquez reasons. So in theory, using $150 billion of the $700 billion bailout to fund more tech and VC-backed companies, the U.S. could generate about 5 million new jobs instead of trying to save “dying whales.” But this isn’t even the biggest risk we run, according to Mr. Enriquez. Worse than saving dying whales at the expense of speeding minnows is the risk that our smartest and most innovative assets will, in terms of their ownership, anyway, flee our shores in desperation. “We just vaporized the entire investment banking industry,” he said. “So here is a really interesting question: Who in the world is going to bring companies to the public market? No one. So part of what is going to happen is you’re going to get a whole bunch of smart people from abroad cherry-picking our innovation assets and buying them up on the cheap.” So far, evidence of entrepreneurs fleeing to foreign investors is not present in the data, said Dow Jones VentureSource’s Jessica Canning. But this may be only because it takes six months to a year for a funding round to close—so if entrepreneurs are going cross-border today, it won’t show up until much later. Anecdotally, there have been rumors lately that the giant social network Facebook has been seeking capital for its latest funding round in Dubai. Some VCs in the U.S. say this isn’t because Facebook can’t get U.S. capital, but because the company can’t get capital at the price it seeks, and so is hunting for “dumb money” abroad. Smaller companies also seem to be only too happy to look offshore for funds. “I think founders and CEOs may be looking outside the U.S. for additional sources of capital due to some of the panic and fear running pervasive in the domestic market,” said Andrew Hoag, the founder of a San Francisco-based start-up called inviteme.to, which helps consumers simplify their social activity planning. “My company has half of its investor base from Europe,” he said. “These were primarily personal connections that I had, but in speaking with these investors, they consider the U.S. market to still be a leader in innovation, and with the drop in the dollar, to be a very good deal vis-à-vis local investments.” A small, but not inconsequential point, Mr. Hoag added, is that for regulatory reasons it actually is cheaper and easier for American entrepreneurs to raise money overseas: “The SEC isn’t so concerned about protecting foreigners, and under Reg S you actually can get exceptions to registration laws that normally would require SEC-accredited status.” While it might be good for entrepreneurs that foreign capital is cheaper and easier to come by, a persistent financial markets crisis here and repeated bailouts could pose long-term threats to the younger sectors of the U.S. economy. “Absolutely the innovation economy is at risk,” said Mr. Heesen of NVCA. In an environment like this, fewer people are willing to leave supposedly steady jobs to start companies of their own, and when the brave do, he said, “they simply see fewer sources for their initial funding.” The great bulk of start-ups, Mr. Heesen explained, have been funded through second mortgages or personal credit cards. Today’s entrepreneurs can use neither. Founders next typically turn to friends and family, or to angel investors. But since all players—including angels—have seen their net worth collapse with the stock markets, these sources of capital are also gone. There are VC firms that invest in early-stage companies, but such shops, Mr. Heesen said, have no room for new deals anymore. Foley Hoag’s Mr. Rosenblum, who has weathered many recessions in his career, said, “Experience suggests that what you need to do is open the IPO market.” Of course, no one is sure how to do that. Mr. Heesen said his organization has conducted a series of roundtable meetings with investment bankers, VCs, entrepreneurs, stock exchange officials and lawyers in cities across the country to discuss proposals for how the industry can, with or without government involvement, move the recovery process along. “One thing that has been discussed is, do we need different investment banks that cater to younger, smaller companies? But it’s a chicken-and-egg thing,” Mr. Heesen lamented, “because you can’t have those i-banks if there aren’t those small companies that are lined up and registered to go public.” He notes that right now, the number of companies de-registering from their IPO filings equals those that are registering. Mr. Rosenblum thinks it needn’t take a complete overhaul or recovery of the financial system to revive the IPO market, but simply more stability. “The big problem isn’t the absence of buyers; it’s the fact that you can’t price anything with so much [stock market] volatility,” he said. “That makes it almost impossible to get a deal done.”
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