Wednesday, June 15, 2011

Why IPO Mania May End Up Hurting VCs

Bloomberg published an interesting article yesterday on how the current IPO wave has benefited a select few within the VC community - making the "haves" stronger and the "have nots" more challenged to win deals. I think there is a good deal of merit to the argument that, in the long-term, these dynamics will be bad for the venture community as well as startups, which benefit from increased competition from it's sources of capital (as LendingTree put it, "When Banks Compete. You Win").

However, I would like to focus another consequence of IPO Fever which we should be wary of.

In times like these, every entrepreneur and investor, begins to believe that their company has a shot of going public. That's great. You want that kind of enthusiasm. The problem is, if everyone thinks their company can IPO at $4 billion - they don't mind paying $1 billion in a venture round - which is why you're seeing higher and higher private capital valuations. My argument here isn't that we are in a bubble and that these valuations are crazy. I'm just trying to point out that, statistically speaking the most likely successful outcome for any startup is an acquisition, and when you raise a great deal of capital at valuations in the hundreds of millions of dollars, you effectively price yourself out of the market of being acquired for a good return. Sure, the billion dollar acquisitions grab the headlines, but most acquisitions are in the $0-$300 million range.

Let me be clear. IPOs are a critical part of the business model to venture capital - and what is happening right now in the market is fantastic for investors (albeit to a smaller subset of them, as was mentioned at the top of this post).

However, at some point, the IPO window will close as it always does. The investors that deployed capital at more reasonable valuations will find they have more options for realizing an exit. Those that are only in the "hard to get into" premier billion dollar deals, will have to wait for the next IPO window.

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