The State of Money, Part II: The Private Equity Market for Startups in 2011

March 23, 2011

11:00 am

This is part two of a three part series that looks at the private equity market and what it means for your startup.  In the first post, we looked at the state of the equity market prior to and in 2009 and the impact it had on startups.

What does the market look like in 2011?

The Long Road Home. One major change occurring in 2011 is the slow return of leverage. While this should, in theory, provide greater liquidity for startups and emerging companies, that trend has yet to be seen. In 2010, much of the money primarily went to larger deals—deals below $250 million made up 70% of the deal flow, it was the lowest portion of deal flow in the lower to middle market since before 2005.

Finding the Exits. A major catalyst for the improving conditions is the greater availability of exits for private equity firms. There were more exits in the second half 2010 than in all of 2009. While greater exits mean more liquidity for new investments, the return of capital is not proving to be a fast one in 2011. The primary reason for this sluggish return: a colossal overhang left by crises.

A Killer Hangover. Generally, venture capital firms prefer to invest in companies that have the potential to grow quickly and generate an annual return on investment in excess of 40% over three to five years. Heading into 2011, private equity firms own an all-time high of 5,994 U.S. companies, according to a PitchBook report. High company ownership wouldn’t be such an impediment to firms and the companies looking for their financing if it wasn’t for one fact: the median hold time for exited companies in 2010 is more than five years. In essence, the lack of exit opportunities in 2009 has left the market with a massive backlog of investments that need to be liquidated before investment in new companies can reach pre-crisis levels.

The New Sheriff in Town. The market is seeing a new regulatory framework being headed by the Dodd-Frank Act. Although the attitudes of market players towards the Act have been mixed, there is no doubt that the new regulations are going to mean new hurdles for the private equity market. The exact parameters of the Act have yet to be worked out by regulatory authorities, but it is clear that there will be new registration requirements for previously exempt players, greater disclosure requirements, increased scrutiny of operations and impediments to raising funds from traditional financial intermediaries. Specifically, the Volcker Amendment to the Act prohibits a banking entity from “sponsoring” any hedge fund or private equity fund, with certain exceptions and a transition period. Prior to Dodd-Frank, the more lax Gramm-Leach-Bliley Act governed the relationship between banks and alternative investments.

Blaire Jones and Aaron Horn are the founders of the Georgetown Venture Law Society, an association of professionals and students at the Georgetown University Law Center dedicated to cultivating a greater understanding of the legal and financial issues facing emerging companies.

Image by open flickr member opensourceway.

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Blaire Jones is a law fellow at National Public Radio, where she focuses on technology and intellectual property matters, and a new graduate of Georgetown Law. At Georgetown, Blaire discovered a special passion for helping startups leverage intellectual property and manage risk. You can follow Blaire on Twitter @VenEnthusiast.

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