Venture Capital and the Economy

Today I had some time to explore what the economic downturn means for venture capital investors. The result: no new IPOs and lower M&A exit numbers (source: NVCA reports).

  • No IPO activity for two consecutive quarters (first time on record)
  • 56 M&A exits in Q1 2009; 13 totaled $645MM – in that last 3 years that number has been closer to 100 M&A exits; average value of $49.6MM / exit
  • Due to the lackluster IPO market, corporate acquirers are being more selective and taking their time when considering acquisitions
  • IT sector led the venture-backed M&A market with 42 deals and total value of $348MM

The NVCA also stated that 40 venture firms raised $4.3B in Q1 2009. This happens to be the smallest number of venture funds raising money in a single quarter since Q3 2003.

How are venture firms adapting to the downturn?
VCs are saving funds to support existing portfolio companies that may be experiencing lower sales volumes, or cash flow issues due to problems with accounts receivable or inventory. In addition, VCs are taking more time to support portfolio companies from an operational perspective; it’s a good time to trim the fat, get lean, and bring in some very experienced talent that can now be found readily on the street.

In light of poor IPO and M&A markets, valuations have been pushed down significantly. Companies are once again being evaluated on revenues and other real metrics. There are still many over-inflated venture-backed companies out there and many VCs are waiting for valuations (or valuation expectations) to decrease before injecting cash. It is becoming more of a VCs market to demand their price.

One more thing — since many VCs have closed their doors to new investments, existing VCs can be more selective in the investments they would like to pursue. This increase in stringency will hopefully result in more winners being picked during these trying months.

Bob Mast, who is the Managing Director at Monument Group thinks “the world is divided into 3 groups: people with severe cash flow problems that have halted commitments, people who are over their target and are being very selective, and people who have money but are still nervous.”

Like many others out there, I am hoping for a turnaround and markets to reignite very soon. Until then, I’ll be keeping my head down and trying to pick winners.

Subprime Melt Down Effects on Biotech

I was going through my email today when I came across some really insightful comments made by Jayson Parker, who is an associate professor of my Biotechnology program. With his expressed consent, please review some key points that highlight the effects of the US “subprime melt down” that is taking place and their relevance to the biotechnology industry.

He explains that there are two basic outcomes:

1. Core inflation is priority. If interest rates go up, it hurts biotech (as it is capital intensive and increases the cost of money for loans).

2. The housing market continues to meltdown in the US. If interest rates go down in response to a recession precipitated by the housing meltdown it will also hurt biotech (money is cheaper, but investors will assign a much higher risk to stocks and the flow of money will decrease).

Recapping some events that have take place so far:

  • The US economy has defied gravity for the past several years given the unexpected strength of consumer spending.
  • Consumer spending has been made possible by unprecedented appreciation in housing values and historically low interest rates – consumers have borrowed against this to maintain their purchases.
  • Unlike previous market bubbles, a substantial portion of consumers have leveraged themselves to be part of this current bubble – the housing market.
  • Some consumers have borrowed heavily enough against the price appreciation of their homes – that a strong market correction could leave them owing more money on their homes (negative equity).
  • In a historically low interest rate environment, some mortgage companies have offered loans to high risk clientale (e.g. NINJA – loans to folks with no income, no job and no assets) assuming far greater risk in their client base than is normally prudent.
    These risky loans have been “securitized” – meaning the debt has been repackaged – and through a series of events I don’t follow – have been included in other investment vehicles that affect more broadly the retail market.
  • The housing market in the US – which has seen more growth than in Canada – is the “canary” of US economic outlook – recent interest rate increases have seen an increase in bankruptacy rates among homeowners who cannot make their monthly payments.

Currently, the US federal reserve is meeting over the next two days to decide on whether interest rates will climb – the expectation is that it will remain status quo. Core measures of inflation (excluding indices of energy), indicate that inflation may be a concern which will eventually demand an interest rate increase. Finally, giving the “recap” above, the Federal reserve will likely will be more focused on the Housing market and in keeping bankruptacies to a miniumum by keeping interest rates as low as possible to avoid a recession. Keep your eyes on the subprime meltdown in the US over the next quarter. If we enter into a recession, there will be harder times for biotech.

Once again, I would like to thank Jayson for his insightful comments!