Silicon Valley Frontlines: IPO's and M&A Exits Continued to Improve in Q3 ... Good News for the Trickle-Down Effect

As noted many times before, the availability of funding for startups is heavily influenced by the state of the market for exits - IPO's or acquisitions. If investors don't think they will be able to exit an investment down the road then they won't tend to make it in the first place (duh!). Somewhat illogically, this has very immediate impact on new investments even though the exit will be years down the road and subject to whatever market conditions then exist, going to show that emotion and sentiment is still a significant factor in current decisions.

They good news in Q3 2010 is that while IPO's continued to improve from last year, the sales of venture-backed companies in M&A activities (including two of my prior startups or clients, yea!) increased substantially. This has the effect of (eventually) encouraging more money to go into startups as individuals cashing out then start new companies or become angel investors, and from traditional VC's seeing positive outcomes. In addition more money comes into the local economy from employees and individuals cashing out and buying houses and cars and the usual trappings of success/hard work. (Of course, IPO's aren't strictly exit events but for most earlier-stage VC's they are the start of that process).

According to Thomson Reuters and NVCA there were 14 venture-backed IPO's in Q3, for a total of 40 for this year-to-date, compared to just 18 in 2008 and 2009 combined. The average IPO took 6.7 years and $51m in funding to get there. An additional 49 venture-backed companies are on file with plans to IPO in the near future, representing a healthy pipeline for the rest of the year and into 2011. And of course not including - yet - Facebook, Zynga, LinkedIn or some other hot Valley companies!

Total M&A deals involving venture-backed companies in Q3 were 104, and 322 year-to-date compared to 173 in all of 2009. Two-thirds of the 104 were for computer software or internet companies. The average time it took a venture-backed company to achieve an M&A exit in Q3 was 4.8 years (20% less time than last year's exits) and an average of $23m in venture capital to get there (versus an average $27m in exit proceeds). The latter suggests that on average VC's don't make much money on their investments so it's interesting to look at an analysis of the values of the transactions versus the amounts invested in these companies (so much for averages!):

Analysis of Transaction Values versus Amount Invested
Relationship between transaction value and investment	Q1 10 M&A **	Q2 10 M&A **	Q310 M&A **
Deals where transaction value is less than total venture investment	9	3	7
Deals where transaction value is 1-4x total venture investment	7	4	11
Deals where transaction value is 4x-10x total venture investment	9	9	4
Deals where transaction value is greater than 10x venture investment	4	4	5
Total Disclosed Deals	29	20	27
Source: Thomson Reuters & National Venture Capital Association

I'd expect the overall M&A trend to continue and even accelerate as large tech firms, flush with cash, put some of that money to work (as they should do in the interests of improving stockholder returns over time rather than just punting with stock buybacks or starting to pay dividends).

The reality is that, despite the improvement, an IPO continues to be a hard way to find an exit with more and more companies tending to sell themselves (as we see above) or delaying or avoiding such events until they literally have to. You may remember Google's IPO timing was heavily affected by the company getting to the point of having more than 500 individual stockolders, a key statutory threshold for being considered "publicly held" and almost by default. Facebook has avoided this by allowing big investors to come in and provide liquidity in the near-term to certain employees and others in private transactions and I'll discuss more of this in a future post.

Sources: Thomson Reuters, National Venture Capital Association and Dow Jones VentureWire