Viewpoint October 30, 2009, 4:03PM EST

Don't Bet on a Return to a 'Normal' IPO Market

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Number of VC-backed IPO firms annually, 1980-2008. Source: Jay Ritter's IPO data page accessed at http://bear.cba.ufl.edu/ritter/IPOs2008VC.pdf

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The "normal" number of VC-backed IPOs might be closer to the average of 52 per year we had in the 1980s or the average of 49 per year that we had in the 2000s as opposed to the average of 150 per year that we had over the 1990s.

To see the difference in what normal means if it is defined as the VC-backed IPO rate of the 1990s rather than the 1980s or 2000, take a look at the figure to the right I created from data downloaded from University of Florida professor Jay Ritter's Web site. (Ritter keeps track of the number of VC-backed companies that have gone public every year since 1980.)

Exception, Not the Rule

Just eyeballing the chart suggests that the 1990s might have been the abnormal decade when it comes to VC-backed IPOs.

So what happens if the VC-backed IPO market comes back from current recession-induced level, but only to the levels of the 1980s and 2000s, not the 1990s? The answer is VCs will be in for a fair amount of continuing pain. These investors are backing a larger number of companies than they did back in the 1980s. So a smaller number of IPOs among their portfolio companies will make it harder for them to make a living.

If the IPOs came faster or at a higher valuation, this might not matter so much, but the amount of money raised from the average IPO is lower now than it was at the heights of the late 1990s, and the median age of an IPO firm is double what it was in the VC heyday.

So if the number of VC-backed IPOs only comes back to the levels of earlier this decade or the 1980s, then the VC business will continue to suffer. Moreover, the pain won't be limited to the VCs but will be felt throughout the entire ecosystem that relies on VCs. If VCs have few exits, they won't be making much money. If they aren't making money, then they won't be investing much either. The sophisticated angels who are looking for VCs to follow on their investments in a later round will need to cut back as well, given that fewer VC dollars will be following on the angel investments.

All of this could prove problematic for entrepreneurs who need VC-style equity investments. If there are fewer VC firms around to put several million into a high-growth startup, some of those firms aren't going to get the investment that they need. And that could mean fewer successful companies like Google (GOOG) and Genentech (DNA) that provide jobs for many people and innovative products that are valuable to all of us.

Scott Shane is the A. Malachi Mixon III Professor of Entrepreneurial Studies at Case Western Reserve University.