Why August Was A Bad Month For Startups Seeking Funding

September 9, 2011

3:30 pm

According to Dealogic, 15 scheduled IPOs were withdrawn in August. That’s the highest number of IPOs withdrawn from SEC filing since April 2001.  You remember April 2001, don’t you?  That was a market bubble or two ago, but it was also the beginning of a startup nuclear winter. That’s the bump in the road that, when compared to the market drop of 2009, looks like an Everest-sized mountain in the road.

Do these pulled IPOs mean that your nut-job survivalists uncle who has spent that last 10 years burying cans of tuna and gold bullion in his backyard was right?

According to venture capitalist Mark Suster, prior to the 2001 market dive, there were 2,500 venture capital firms. Today there are about 700.  While many other factors combined to create a perfect storm in public and private equity markets, the IPO market is more than just a gauge of the health of the economy,  because it is the liquidity and market returns of a healthy IPO market that provides fuel for the private equity markets.  A dearth of IPOs translates to a dearth of liquidity, which can lead to startup leaders metaphorically abandoning their lifeless vehicles on the side of the road .

Unlike the US Government, venture capitalists do not print money.  They depend on deep-pocketed Limited Partners (LPs) to invest in VC funds; they are institutional investors like large banks, insurance companies, pension funds, endowments, and wealthy individuals.  When venture-backed companies go public, this generates cash returns for LPs, that, when flush with cash, tend to reinvest in venture funds.  No cash liquidity? No cash investment.

For angel investors who invest their own cash in start-ups, the drop in the market that leads to IPOs being pulled translates to long list of strong public companies now being offered at bargain basement prices. This means that private valuations must go down significantly to be in line with a rational risk/reward ratio.  Today’s stock market prices are an incentive for angel investors to favor the more liquid public markets.

It is cause-and-effect and not merely a coincidence that public market success is a predictor of the health of the venture funding environment. Therefore, August may be a harbinger of things to come.

Dealogic reports that there are 115 companies in some stage of the filing process to go public in the next 6 months. Even with the hiccup in August, 2011 has been the strongest year for IPOs since 2007.

Let’s hope that August was a hiccup and not a major case of indigestion.

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Glen Hellman (@glehel), is an angel investor, serial entrepreneur, and works for venture capitalists as a turn-around specialist. He is the Chief Entrepreneureator at Driven Forward LLC, frequently muses on his blog, Forward Thinking, and works with entrepreneurs to help them figure out what to do and get them to do it.

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