Venture capital investors play an integral role in the development of start-up companies by providing needed funds to high-risk, early-stage companies with strong growth potential. Venture capital investors provide entrepreneurs with initial seed money and additional financing at various stages of the often fast-paced growth process, with the ultimate goal of either taking the company public in an initial public offering (an “IPO”) or selling the company to, or merging it with, a larger, an established industry player.
Current economic conditions, however, have brought venture capital investments to the lowest level in years. The small, high-growth firms which benefit most from venture capital are particularly susceptible to downturns in the broader market, making what are already perceived as high-risk investments in such companies even riskier. As a result, new venture capital fundraising is down significantly to just a fraction of funds raised in previous years.
In addition, the two traditional means of achieving returns on venture capital investments (an IPO or a sale to a larger company) are largely unavailable. The IPO market has come to a near standstill, although some are forecasting marginally increased activity later in 2009. The market for mergers and acquisitions has similarly declined. As a result, venture capital investors are unable to exit their current investments, and, if an exit is possible, it will likely represent a substantial or total loss, further chilling the market for new venture capital investments.
A new group of secondary investors is emerging to pick at the carcass of current venture capital investments. These investors purchase the interests of current venture capital investors at a substantial discount, hoping for later gains when the IPO and mergers and acquisitions markets thaw. This secondary market at least provides some liquidity to those currently stuck in venture capital positions.
Despite this dour news, there is some reason for optimism. There is evidence that corporate acquirers are taking tentative steps to reenter the market for start-up operations, albeit on conservative terms. Some larger companies are using these difficult times to make strategic purchases of start-up companies, as evidenced by Google’s recent creation of a $100 million venture capital fund. Learn about the Google venture capital fund. In addition, well-positioned emerging companies are increasingly taking advantage of the distressed balance sheets of public companies, acquiring technologies and operations from these companies at a relatively depressed price. This practice was virtually unheard of before the current downturn.
In short, while the current state of financing for start-up companies is glum, the market for innovation and high-growth companies will return. The entrepreneurial spirit has and always will survive difficult markets, and investment assets invariably seek out the brilliant new cutting-edge companies and innovations that will shape the future.