At the end of August I noted with surprise that three midsize tech companies had filed to go public in the US, and said that there success in making the next step to actually listing would tell us a lot about the state of the market. In the last couple of days we have heard that Groupon, the tech company everyone loves to hate has cancelled its roadshow and is reassessing its plans to IPO, and Zynga is also facing delays (although not as severe), and this comes on top of news that more IPOs were pulled in August than in any month for ten years.
Entrepreneurs and their investors make money when companies are acquired or when they IPO, with the bigger checks usually coming from IPOs. The upshot of this is that a healthy IPO market has been the most important driver of returns to VC funds, which has a direct knock on effect on the amount of money available to invest in startups and startup valuations.
Given the centrality of IPOs to the startup ecosystem there are two conclusions to be made from the chart below a) the low level of IPO activity since 2001 compared with the prior five years goes a long way to explaining why the last ten years have been difficult, and b) it is easy to understand why the pick up in the last quarter got everyone so excited.
The startup ecosystem has responded to the dearth of IPOs in two ways, with more M&A, and by developing markets for shares in companies while they were still private. These secondary markets have a number of flavours – market places like SecondMarket, investments from hedge fund type vehicles like DST, and placements by investment banks, but all of these markets are underpinned by the assumption that the companies would eventually achieve a traditional exit, with many of the companies trading at valuations which are only likely to be topped by a big IPO. Hence, whilst the IPO might have become slightly less important in the short term it is still central to the efficient working of the system.
If and when Facebook goes public, and how it fares if it does, will be a very important driver of sentiment and could even set the tone for the whole startup and venture ecosystems for a good couple of quarters.
The underlying drivers of innovation and startup activity remain as strong as ever, but we are all heavily impacted by the overall macro picture and need to bear that in mind as we strategise on how to build our companies and funds.