Investment Banking and Venture Capital in 2010: The Opportunity in the Crisis

I recently attended a 2010 Outlook for the Investment Banking and Venture Capital industries, an event hosted by Polsinelli Shughart PC . In addition to thanking Polsinelli Shughart, I'd like to acknowledge two excellent speakers featured at the event: Wayne Nielsen of W.G. Nielsen & Co. and Stephanie McCoy, most recently a venture capitalist at Meritage Funds.

Stephanie, speaking from a venture capitalist's perspective, addressed the liquidity crisis; Wayne, who made some remarkably accurate predictions last year for 2009, made 2009/2010 economic observations that contrasted the carnage of 2008 with some encouraging trends from 2009. Both speakers highlighted the lows, but followed with some signs of promise.

What everyone wants to know is: How do we work our way out of last year's economic abyss, and when do we see a light at the end of the tunnel? What is the impact that the absence of capital markets will make on the types of innovative, early stage businesses that characterize our Colorado business community, especially in the emerging business sector of renewable energy and other sectors that are at the heart of our economic health?

Here are some notes from both presentations and key takeaways from the event. Any editorial commentary is my own!

A Venture Capitalist's Perspective

• Institutional investors all but disappeared in 2008 and through much of 2009, leading to the precipitous decline in funding to the VC industry.

• Institutional commitments to venture firms were $5B year-to-date in 2009; down from $23B in 2008 and $40B in 2007. (The number was $80B in 2000).
• The number of venture investments followed suit, both in number of investments and in the size of the investments.
• Early stage companies were hardest hit. $2.4B went to 536 companies in 2009 (YTD); down from $6B invested among 2550 firms in 2008, and $7B to 2852 companies in 2007.
• Exit strategies became a memory of the past. The IPO market ground to a halt- especially for small cap firms. And as Wayne predicted, M&A activity in 2009 has declined more than 40% from 2008 and more than 80% from 2007.

The result: Companies retrenched and venture firms marshaled their remaining capital.

And there are some seemingly favorable indicators of an improvement in the venture industry, as seen in a survey of the top 100 institutional investors.

• Despite a virtual stoppage of venture sector investments, over 90% of surveyed firms indicated their intent to continue to invest in venture capital firms.
• More than 30% indicated that the level of their investment as a percentage of their allocation would increase.
• Only 6% indicated their intention to reduce their percentage exposure to venture capital investments.
• Private equity funds currently have approximately $400B in investment capital available, while commercial banks and lending institutions have approximately $1.2B in cash assets.

What's not so clear is: How much remaining capital have VC firms retained that is not likely to be limited to follow-on investments?

An Investment Banker's Perspective

There is no question that the picture here is complex. Without a healthy investment banking industry, the parties affected by the events above are absolutely affected by the lack of access to capital along the way. They are critically affected by the inability to achieve liquidity events through public markets or M&A transactions. We hear much in the press--repeatedly--about economic sectors: Retail sales and consumer confidence, low housing starts, mortgage foreclosures, the federal debt, and the implications of the bailout.

Despite Warren Buffett's admonishment, "Anyone who thinks the market knows the value of anything needs to do more homework," some indications of favorable trends include:

• The DOW, Nasdaq Composite, and the S&P 500. They're all up between 60% and 70% since March of 2009.
• Low price/earnings ratios and skyrocketing worker productivity. Decade-long highs indicate a likelihood that business profits will improve.
• Increasing U.S. manufacturing activity throughout 2009.

Physics warns us, however, that for every force there is an equal and opposite force. Many of these indicators mirror the relationship between high productivity and high unemployment, etc.

The IPO market seems to be returning.

• Q3 2009 saw an IPO volume of 20 deals producing $5.8B of equity investment.
• As of October there were 34 registrants in the IPO pipeline, up from 28 registrants seeking $7.6B on June 30, 2009.
• Only 12 companies went public in the first half of 2009; 8 were US-based.

What does this mean for Colorado and its sustainable startups?

The venture capital landscape in Colorado is experiencing some uncertainty with a number of firms in fundraising mode. Our venture investment reality is that 80-90% of venture capital comes from out of state. At the same time there's another development occurring. We are experiencing an explosive emergence of the cleantech/renewable energy sector which saw 76 Colorado companies apply to make presentations at this year's 22^nd annual NREL Industry Growth Forum. About the same number of applications came from California, and is almost double the number of Colorado-based applications from the previous year. However, while the general impression seems to be that regional firms are having difficulty raising money, the reality is a bit more mixed in my mind as evidenced by (if my facts are correct) a number of firms that have in fact raised money within the past few years: Foundry Group, Altira Group, Infield Capital, Access Venture Partners, Boulder Ventures and Meritage Funds. And there are other smaller funds emerging on the landscape. Demonstrative of a transition, Altira Group is, and has been, entirely focused on energy technology. Infield capital was formed to focus their investments on cleantech-related vehicle powertrain technologies, and Access Venture Partners has become active in the cleantech space.

During a follow on visit with Stephanie, we discussed the regional VC landscape. She agrees that, while the cleantech sector is an area of great opportunity, it's relatively immature; it struggles with uncertainties around government policies and subsidies, and developing convincing business models. We both were reminded of Colorado's cable industry during the 1970s--how it developed a critical mass here, despite regulatory challenges, and was supported by some of Colorado's most prominent venture capitalists, visionaries, and leaders.

We know that venture capital flows to great new ideas in the hands of seasoned entrepreneurs. Perhaps we're going to see a similar evolution in the cleantech space, and the influx of established energy companies will attract capital and new management talent. Do we have the necessary ingredients? I invite your views.