While the lack of high-profile IPOs may have eliminated one avenue for venture capitalists to realize a return on their investments, it’s not necessarily a bad thing for the entrepreneur. Increased regulations and higher investment banking fees make the process of taking a start-up public more difficult. “To be honest,” Allen Lau says, “I’m not sure that’s the path most entrepreneurs should take anyway. Ten years ago, Facebook and Zynga would have gone public long ago, but today they’ve chosen, so far, not to because all the regulations and the overall environment is different.”
Attorney Rubsun Ho, a partner in the Toronto-based “virtual” law firm Cognition LLP, which does extensive work with start-up technology companies, has seen a significant increase in the number of companies exiting at an earlier stage. “There are a lot of companies selling out in the $20-to-$25-million range,” he says. “Instead of pursuing a [later stage] round of funding, a buyer comes along and the company takes the offer.”
Ho remembers a far different environment for raising capital in 1999 and 2000. “At one of the companies I was involved in, we did a raise of $50-million and all we had was a PowerPoint presentation,” he says with a slight, almost embarrassed, chuckle, noting that at the time the company barely had any revenue but that the deal was still “oversubscribed” (with more people willing to fund it than was required). A $50-million raise? Today a start-up would make headlines for even exiting at that level.
“We don’t want to compare anything to ‘99 or 2000,” Union Square’s Wilson cautions. “Those two years were an aberration.” Of course, Wilson is in the enviable position of helming a U.S.-based VC fund with a sterling track record, with investments in Foursquare, Tumblr, Twitter and Zynga, among others. The U.S. VC industry may not be as impaired as Canada’s, but the ability of funds that don’t boast Union Square’s portfolio to raise new capital has not fully recovered to pre-crash levels. In fact, numbers recently released by the National Venture Capital Association and Thomson Reuters show 52 U.S.-based VC funds raised $1.72-billion (U.S.) in the third quarter of this year, down 53 per cent year-over-year and the lowest amount raised in the third quarter of any year since 2003. More worrisome, the decline in the third quarter comes after two impressive prior quarters (year-to-date, U.S. VC fundraising is still up 26 per cent year-over-year, by dollars), suggesting that start-ups on both sides of the border may be about to face renewed risk aversion from both VC firms and their investors.
Risk aversion: The new normal
Given the perilous state of the global economy, it should come as little surprise that today’s investor is more interested in safety and return of principal, as opposed to risk and return on principal.
Peter Atwater, president of U.S.-based Financial Insyghts, a macroeconomics consulting firm, and author of an upcoming book on social mood, decision-making and financial markets, points to the market’s current preference for dividend stocks, particularly of the world’s largest corporations. “These are the antithesis of the ‘concept’ stocks of the late 1990s,” he says. “Today everything requires a proven track record rather than the prospect of opportunity. It’s all very rear-view- mirror focused.”
To make his point, Atwater notes the reaction to Apple co-founder Steve Jobs’s recent death. Media column after column lamented the fact that there was no other Steve Jobs out there waiting to assume the mantle of tech visionary, and, to be clear, stepping into the stratospheric airspace Jobs occupied as a tech leader and innovator is hardly an easy task. Still, it’s as if his death marked the end of innovation itself. “No wonder people aren’t putting money into venture capital,” Atwater says. “It’s the perception that there are no new opportunities, people or ideas worth investing in.”
According to Atwater, at the top of what he calls the social mood cycle, investors have a tendency to put the cart before the horse. “They put ideas ahead of revenues,” he says. Today, it’s the reverse. “Not only does the market want the horse in front of the cart, they want to make sure that the cart is filled with gold.”
In other words, the downturn has brought with it, as downturns always do, an increased level of scrutiny. It’s no longer enough for an entrepreneur to approach potential investors with little more than a PowerPoint presentation and a dream. More discipline is demanded, as well as stronger execution.
Although this can prove painful for the start-up entrepreneur working out of his or her garage, it’s not necessarily a bad thing in the end. “I think we kind of went into the trough in Canada, but we really did shake off a lot of the chaff,” says GoInstant’s MacDonald. “There’s still a marketplace for good ideas, though.”