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Technology companies ‘cautiously optimistic’ about exit strategies

20 November 2009 No Comment

By Helen Kaiao Chang

See original story on SDNN

Friday, October 16, 2009

Money is tight for technology companies, and many will need more cash next year.

But many executives see hope for the future, as company valuations rise and access to capital continues to improve, said business executives in a survey released Friday by San Diego-based law firm Foley & Lardner.

“One aspect of the data that jumps out at me is the belief that there will be less venture capital available in the foreseeable future,” said Adam Lenain, an attorney at Foley & Lardner in San Diego. “Fewer new funds will be formed in the coming five years, shrinking the total pool of available risk capital.”

Yet increasing valuations means the market is turning a corner. “More hopeful predictions for access to capital and valuations indicate we’ve reached the bottom of the market,” said Gabor Garai, chair of Foley’s Private Equity and Venture Capital Practice. “Emerging company executives are cautiously optimistic about available exit strategies.”

The survey participants were queried in September and October at the law firm’s annual Emerging Technologies conferences in San Diego and Boston. Respondents also participated via Twitter.

The survey queried 230 respondents, comprising 52 percent emerging company executives, 40 percent outside consultants/advisors and 8 percent investors. “Emerging” companies were mostly less than five years, in industries including IT/software, telecom, alternative energy, medical devices and biotech.

Early stage companies are hit particularly hard, said Lenain. “This is something we have been feeling in San Diego for some time and it looks like that trend will continue. It is increasingly important for these start-up ventures to position themselves correctly and seek funds from sources that continue to invest in proof-of-concept state projects.”

Among the survey’s key findings:

More emerging companies see mergers or sales as their exit strategy. The survey found that 61 percent planned a merger or sale in 2009, up from 53 percent in 2008.

Companies are accelerating their plans for mergers or acquisition. Some 21 percent shortened of survey respondents shortened their timeline in 2009, compared to 11 percent in 2008.

The survey authors wrote: “We attribute this data to a cash flow issue as companies in distressed situations look to a merger or acquisition as they lack the capital to stay afloat.”

Few companies expect to exit through the public market. The number of companies planning to sell their companies through an initial public offering (IPO) remained small, at 3 percent.

Companies are seeking capital for survival more than for growth. A majority of companies – 70 percent – obtained funding in the last year, up from 61 percent in 2008. In addition, most companies – 64 percent — expected to seek funding again in the coming year.

“We attribute this finding to companies needing capital for survival as opposed to growth as their businesses continue to struggle,” wrote the report’s authors.

The investor community is thinning out. Successful venture capitalists continue to raise money, while unsuccessful ones are walking away. The number of investors who do not plan to raise new funds has jumped from 5 percent in 2006 to 44 percent in 2009. Meanwhile, another 50 percent do plan to raise more funds.

The trend, the authors wrote, “is indicative of a fundamental shift in the venture capital paradigm. Due to dismal returns, we’re seeing a fallout in the number of VCs who will survive. The top VC funds are continuing to aggressively raise money, whereas the rest are choosing to walk away.”

Companies are more optimistic this year about valuations and capital access. In 2009, 72 percent of executives believe company valuations will grow in the next two years, jumping from 38 percent who believed so in 2008. A majority – 73 percent – also think access to capital will improve. “This mirrors optimism expressed in the outlook for emerging company valuations,” wrote the survey authors.

Venture capitalists are taking advantage of the economic climate to negotiate better terms and valuations. However, the percentage saying they did this dipped from 62 percent last year to 56 percent this year.

Some executives believed that the tight market was harmful to companies. “It allows those competitors who happen to have capital an opportunity to fill in the
entrepreneurial niches thereby squeezing out emerging companies and investors.”

But many others also said tight capital spurs innovation. Said one respondent: “I believe one of the best tools to enhance innovation is to constrain resources. Tight resources greatly increase the probability the organization will think outside the box and develop innovative solutions.” 

Follow Helen on Twitter @HelenChang.

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