The tech sector's silent alarm: Venture capital drying up

The tech sector is experiencing a crash -- not of stock prices, which rebounded somewhat on Wall Street on Tuesday -- but in its ability to take new companies public.

So far this year, there have been just six venture-backed Initial Public Offers (IPOs); last year, there were 86, according to the US National Venture Capital Association (NVCA). The recent collapse of investment banks Lehman Brothers and Bear Stearns is exacerbating the problem.

Last week, the NVCA's board, whose members include leading venture capital firms, agreed to create several blue ribbon committees to investigate the causes behind the dramatic decline in IPOs. Whether the falloff is due to regulation that emerged after the dot-com bust or the recent failure of investments banks, the committees are charged with recommending fixes that would get venture capital flowing again.

If there are no IPOs, "the economy as a whole starts to stagnate, because these are the companies that really create jobs and move the economy at the end of the day," said Mark Heesen, president of the NVCA.

There were no venture-backed IPOs issued in the second quarter of this year -- the first time that's happened since 1978. In announcing those results in July (download PDF), Heesen said it indicated a serious problem for the economy. "We view this quarter as 'the canary in the coal mine."

Two months later the world found out what killed the canary.

PricewaterhouseCoopers, in a report released Monday (download PDF), said the venture-backed IPO market is now at a 30-year low -- even though venture capital firms are continuing to invest and "raising funds at a steady pace." That means it may take longer for a company to move to a public offering, but the firm will be "even more stable" once the IPO takes place.

Venture capital can be a risky business, with IPOs often the payoff for an investment. So it's not surprising that venture capital firms have continued to make substantial investments in new firms, such as Facebook. In the second quarter of this year, venture capitalists invested US$7.4 billion in 990 deals, with the software industry getting 219 deals valued at US$1.25 billion. But if it becomes increasingly difficult to take companies public, it may become harder for start-ups to get funding.

In the dot-com era, Silicon Valley's tech industry had ready access to boutique investment firms that were ultimately taken over by the big New York firms, said Mark Jensen, national managing partner of Deloitte's Venture Capital Services. With Lehman and Bear Stearns now gone, "that's a radical transformation on Wall Street that we're just beginning to see and think about what the consequences will be."

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