US VC stays strong despite few IPOs

New data from the National Venture Capital Association shows that long-term performance in the US remains strong despite dismal IPO valuation. Dave Keating reports.

A new performance review by the National Venture Capital Association and Thomson Financial may not have brought good news on the IPO front, but it did show that US venture capital still outperformed the public markets in the fourth quarter of 2005 and is showing its strength over the long term.

The review, released earlier this week, showed that although one-year venture capital returns slightly decreased to 15.6 percent in the fourth quarter from 17.9 percent in the third quarter, long term performance for venture capital remained steadfast. Venture Capital enjoyed 20 – year returns of 16.5 percent, and 10 – year returns of 23.7 percent. In contrast, buyouts produced 20 – year returns of 13.3 percent and 10 – year returns of 9.2 percent. In addition, Venture capital continued to outperform the Standard & Poor’s 500 in the fourth quarter.

However there was little good news on the IPO front, which has seen few public exits for early-stage companies. The venture-backed IPO market saw a volume and valuation drop off in the fourth quarter with 17 venture-backed companies going public. And a recent poll on VC exits by the NVCA and Thomson showed that only ten venture-backed companies in the US had IPOs in the first quarter of 2006, raising $540.8 million. While the first quarter is typically the lowest of the year for IPOs, offer amounts were also down considerably. The first quarter’s average offer amount was $54.1 million, the lowest average since the third quarter of 2002.

“We’re seeing a fairly significant further drop in median valuations,” said John Taylor, head of research at the NVCA. “More of these companies are coming into their maturity now, entering a later stage. Normally that would be when these companies would go public or be acquired, but it’s just not happening this time around. Valuations are very poor. Companies are probably reflecting on whether going public is even worth it in light of the regulatory environment.”

At the same time, the venture-backed M&A market is filling in the gap. M&As continued to perform strongly with 95 companies being acquired with a disclosed value of $4.8 billion in the first quarter of 2006, the highest total disclosed value in five years.

Mark Heesen is concerned about the lack of IPO activity

NVCA president Mark Heesen says that, although he is encouraged by the strength of the acquisitions market, VCs cannot rely on it as the only avenue to produce above average returns. “This situation needs to show signs of improvement before year end or we will begin to feel the effects on a much broader scale,” he says.

Taylor agrees. “A company can do very well being acquired. But there’s no question that the greater success stories, even in low valuation periods, come from IPOs,” he says.

The IPO activity that did occur in 2006’s first quarter was driven by the life sciences sector, which accounted for seven of the ten IPOs. Altus Pharmaceuticals’ $105 million offering was the largest IPO of the quarter, backed by Warburg Pincus, US Venture Partners, CMEA Ventures, China Development Industrial Bank and Nomura International. The life sciences sector in total raised $309.8 million. The remaining IPOs came from the technology sector, where three companies raised $231.1 million in IPOs.

However Taylor remains hopeful, saying that the continued strong numbers for venture capital may help lure investors back to IPOs.

“What you’re seeing are institutional investors being very cautious right now,” he says. “They recognize that this industry has and probably will continue to outperform the market, but they’re still being very selective about which funds they put their money into.”