The New York Times has had a couple of articles over the last few days highlighting the difficulties for venture capitalists in exiting their investments in start-up companies - whether it be through sale or IPO of the company or through selling their investments in the secondary market.
Typically, venture capital investments in start-up companies are expected to produce some sort of exit opportunity within three to seven years. Ideally, the company in which a venture capital firm invests is sold at a higher valuation to a larger company or completes an initial public offering (IPO). For example, according to the NYTimes article, Cisco acquires 10 to 15 technology companies a year. And in 2007, over 75 venture capital backed IPOs were completed.
Unfortunately for venture capital funds, as this Reuters article notes, venture-backed IPOs were down precipitously in 2008 - by one estimate only six were completed in 2008. And companies like Cisco are dropping their acquisitions - in 2008 it only purchased five companies. As the stock market continues to be volatile and economic uncertainty abounds, few believe there will be much improvement in 2009 in this arena.
For investors in venture capital funds, this lack of exit opportunity for their portfolio companies leaves few options for freeing up their cash in the short term. Investments in venture capital funds are illiquid and investors go in with a general idea of the minimum amount of time their capital will be tied up. However, in this difficult economic environment, many of the limited partner investors in venture capital funds - including pension funds, insurance companies, college endowments, etc. - are looking for ways to free up cash. Some institutional investors have portfolio ratios they are required to maintain - capping the percentage of funds to be invested in venture capital firms. With their other portfolio holdings devaluing over the last six months, these firms suddenly see their venture capital holdings breaching those percentage caps and are required to liquidate some of their venture capital fund holdings.
This is creating a situation where limited partners in venture capital funds are forced to sell their ownership interests into the secondary market at severely depressed prices. This NYTimes article today details the plight of limited partners in venture funds who are selling their interests to secondary firms for at least a 40% discount. Forced selling of course creates an abundance of supply and further depresses prices. The only other option for freeing up cash is for venture fund managers to try to force a distressed sale of their portfolio companies to get whatever cash they can for their investment - something they may or may not be able (or willing) to do in this market.
Here(pdf) is the NVCA report on 2008 venture-backed IPOs and acquisitions.
Update: An article here from the NYTimes indicating that the IPO slump is expected by many analysts to continue well into 2010 - bad news for venture capitalists.
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