Initial public offerings of companies funded by venture capitalists (VC) fell in the first quarter to the lowest level in over a year, while the total amount paid in merger and acquisition deals hit a four-year high, according to surveys released on Friday. IPOs have traditionally been the exit of choice for growing companies hoping to financially reward top management and investors, but the latest data show that could be changing. The drop-off suggests a potential shift in exit strategies among venture-backed companies, Thomson Venture Economics and the National Venture Capital Association said in one of two surveys released on Friday.
"There is evidence to suggest that the hurdles to go public have been raised from both a regulatory and a market perspective," NVCA President Mark Heesen said.
Those hurdles make mergers and acquisitions more attractive to fledgling companies.
Thomson Venture Economics and the NVCA said 10 venture capital-funded companies raised $720.7 million from IPOs in the first quarter - the lowest level since the third quarter of 2003, when 9 venture-backed companies raised $732.8 million.
The pipeline of deals is also less robust.
At present, there are 38 venture-backed companies in registration with US regulators and preparing to go public. That compares with 57 companies in registration at end of 2004, Thomson Venture Economics and the NVCA said.
Meanwhile, 79 venture-backed US companies were acquired in the first quarter for around $7.07 billion. That is the highest total amount paid for venture-backed mergers and acquisitions in four years, although the number of M&A deals declined from the 102 completed in the first quarter of 2004, according to the Quarterly Liquidity Report released on Friday by VentureOne, a unit of Dow Jones Newswires.
Factors dampening the IPO market for small companies include required revenue run rates, the demand for larger deals in the public markets, and the cost and hassle of Sarbanes-Oxley corporate governance compliance.
In the first quarter, governance rules meant to shore up internal controls at public companies not only caused hundreds of public companies to report deficiencies in their controls, but also played a part in slackening the overall issuance market, analysts and bankers said.
In total, there were 29 IPOs in February but that fell to 7 in March, according to data provider Dealogic. A year ago, there were 20 IPOs in February and 17 in March.
"Going into the end of the first quarter, there was a reluctance by accountants to give comfort on financials prior to 10-Ks (annual reports) being filed, which caused a slowdown in issuance," said Quinten Stevens, co-head of equity capital markets in the Americas for J.P. Morgan Chase & Co.
Stevens said issuance should start picking up again in April.
There was also a lack of big-name deals in the first quarter to get investors excited about the IPO market, said Sanford C. Bernstein analyst Brad Hintz.
"It's the 'name' deals that hit the front page of the papers, and they get the retail investors excited and the institutional investors excited," Hintz said.
Some of those deals should hit in the coming quarters. For instance, Warner Music Group Corp, the record company taken private last year in a buyout deal led by media mogul Edgar Bronfman Jr., having filed to raise up to $750 million in an IPO.
But Hintz said Wall Street has become more demanding in the type of deals it will bring to the market since the Internet and telecom bust. "The Street itself had been more cautious about the quality of deals coming through," he said.