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Weak IPO market could derail healthcare business funding

on June 22, 2011 Source: Kauffman Foundation

Venture capitalists have a message for healthcare entrepreneurs, and it reads like this:

“If you’re considering an initial public offering, don’t.”

That’s on the footsteps of a new study from Deloitte and the National Venture Capital Association.

According to the study, about 80 percent of VC players say that not only is the IPO market at “very weak” levels, it’s also so low, there is some question that some VC markets around the world might be in danger of collapse.

A sick, fragile IPO market would indeed be bad news for healthcare business owners. With IPO proceeds heading south at a rapid clip, that cuts deeply into a big profit center for venture capitalists. Usually, VCs are at the front of the line of investors who are paid handsomely via IPOs. But with the market for new pubic offerings in the tank, that leaves a lot of venture funders with empty pockets, and that means less funding money for new healthcare businesses.

Says the study:

The survey, conducted annually, reveals that venture capitalists believe high returns generated by IPOs are critical in providing superior returns to limited partners and growth capital to developing portfolio companies.

The news isn’t all terrible. The rate of IPOs hitting the market is up 27 percent from 2010 to 2011, but the levels are so low – there have only been 75 new public offerings so far this year – that any talk of progress becomes irrelevant.

For U.S. entrepreneurs, the IPO slump may particularly hit close to home, both literally and figuratively. Here’s how the Deloitte and NVCA study ranks country economies by the importance of having a vibrant IPO market:

  1. United States
  2. China
  3. Brazil
  4. India
  5. France
  6. United Kingdom
  7. Canada
  8. Germany

How do the study authors back those rankings up? By venture capitalists’ sentiment.

According to the study, 91 percent of venture capitalists say the U.S. is a “critical” market for the global IPO market. But only 36 percent of U.S. VCs deem global IPO markets in the same regard.

The study authors describe IPOs as the ultimate “trickle-down” wealth producer for the U.S. economy. They generate jobs, capital, and confidence in the U.S. economy, they say.

"The venture-backed IPO market has been an extraordinary creator of economic value in countless ways,” says Mark Heesen, president of the National Venture Capital Association. “Not only have millions of jobs been created, but superior returns have been delivered to pension beneficiaries, endowments and charitable foundations for decades. Entire industries have been formed, pushing innovation forward, and changing the way we live and work for the better.  The recovery of the IPO market, both here in the U.S. and abroad, is not a nicety but a necessity for the future health of the global economy."

So why the pullback in IPO activity? The Deloitte/NVCA study points to an increasingly frustrating, but obvious reason, the sorry state of the U.S. economy. Here are the reasons for the IPO slowdown, according to the report authors:

  • Weak investor appetite for equity in public companies
  • An unstable economic environment                                       
  • A dim environment for stock market coverage                     
  • Lower participation by investment banks                              

Taken together, the study is a sour one for healthcare startup owners. Surely, the economy will grow stronger, but the current environment for new capital funding looks a lot like a market bottom.

"There is no doubt that the limited IPO market impacts investors and limited partners, but it's important to remember that it affects entrepreneurs as well," said Scott Tobin of Battery Ventures GP and head of the firm's Israel office.  "When I talk to these folks, whether in the U.S., Israel or anywhere in the world, they dream of solving big problems and building long-lasting public companies that survive beyond their tenure as CEO. You need a healthy IPO ecosystem to encourage that innovation and ensure that these incredibly smart and talented individuals truly reach for the stars."

Again, not all the news is grim. Deloitte says that five years out, over half of venture capitalists (57 percent) will increase their funding activity. Another 35 percent say they will keep funding levels right where they are.

For healthcare entrepreneurs, their industry – along with information technology and clean technologies – is at the top of the list of desirable industries for investment.

So take that bit of positive data away from an otherwise dark, dank and dismal IPO landscape. After all, today’s funding menu may look like thin gruel, but a more ample one awaits those entrepreneurs with the patience of a saint.

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