The Worst IPO Market on Record?

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In previous years, say VCs, successful and fast-growing companies such as the social-networking sites Facebook or LinkedIn would consider going public sooner rather than later. But due in part to new government regulations enacted after the corporate scandals at the turn of the century, it's become more costly and time-consuming to take a company public. Two-thirds of venture capitalists surveyed believe venture-backed companies are less likely to want to go public than three years ago, according to the NVCA survey.

Some Good News

It's not all doom and gloom, though. In many ways, mergers and acquisitions have taken over the historical role that IPOs used to play as a so-called exit strategy, although M&A volumes are down as well. Microsoft (MSFT), eBay (EBAY), Google (GOOG), Yahoo! (YHOO), and Hewlett-Packard (HPQ), among others, have been buying up promising startups that perhaps otherwise would go public. Many investment bankers remain hopeful that the cycle will reverse in the fall, especially if the stock market settles down.

Big pension funds that invest in venture capital funds are largely taking a long view. Brandon Park, senior vice-president for Pacific Corporate Group Asset Management, which manages $15 billion for the California Public Employees' Retirement System and other large state pension funds, says his clients are putting the same percentage of their money in venture firms as in the past—and in some cases are boosting their investments. "Rather than trying to time the market, we have a long-term view," says Park. "We are not diminishing our venture capital allocation."

Areas of Concern

But while VCs will be thrilled to hear that note of optimism, it doesn't take away the many concerns they have today. VCs typically make a big profit when the companies they finance sell stock to public investors. But the median amount of time it takes to bring a company public has risen to 8.6 years, the longest time in 27 years. "With the softer economy it's tough to get predictable revenues and earnings," says Dave Power, a partner with Fidelity Ventures. "Results are a little tougher these days."

Part of the issue is that banks have raised the bar for startups to go public. Last year, investment bankers could take a company public that had just turned profitable. This year, companies need a few quarters of profits underneath their belts. "Now we will probably try to lead with companies that have a longer track record of profitability," says Laurence Goldberg, managing director and head of technology investment banking for Lehman Brothers (LEH).

Even the market for mergers and acquisitions has softened this year, pouring salt in the wounds of VCs. In the 1990s, mergers and acquisitions accounted for about a quarter of the exits of venture-backed companies. In the new century, that dynamic has flipped entirely. Last year, for example, there were 86 IPOs, compared to 355 M&A deals. This year, there have been 120 M&A transactions, down 28% from the first half of last year when there were 169 deals.

VCs know they will probably never see a return of the glory days of the 1990s when 200 IPOs a year was par for the course, and unprofitable companies like Pets.com sold shares to the public. But Dixon Doll, a co-founder of venture capital firm DCM, says he hopes the industry can see at least 100 IPOs a year at a minimum. To make that happen, Doll, who is also the chairman of the NVCA, is lobbying Congress to relax financial reporting regulations on small companies, keep taxes on venture capital at today's rates, and impose uniform global accounting standards for startups. He says it's important for the country's future to reverse the IPO trend of this year. "We have to change the negative psychology," says Doll.

Ante is the computers department editor for BusinessWeek.