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IPO Activity in Danger Amid Market Meltdown

Persistent turbulence in the financial markets and growing fears of another recession threaten to put breaks on the initial public offering (IPO) activity in the second half of the year, and may dampen prospects for such high-profile deals as Groupon and Zynga.

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As European bank shares hit their lowest level in nearly 29 months Friday, IPO industry insiders say state of the global banking sector is among their top concerns. Horace Nash, partner at Silicon Valley law firm Fenwick & West, believes another financial crisis would be a major hurdle for the IPO market and could spark a 2008-style freeze-up.

In 2008, the number of priced deals plummeted to 31 from 214 a year earlier, and the number of IPO withdrawals jumped to 103 from 51, according to data from Renaissance Capital.

Venture capital investors, an important source of funding for startup firms, expressed similar concerns about financial markets meltdown and macroeconomic trends even before the August market rout.

“There is a risk that politically induced economic uncertainty in the U.S. and Europe could dry up liquidity in the financial markets and among corporate acquirers, which could constrain the exit market,” said in July respondents to the latest Silicon Valley Venture Capitalist Index survey.

The survey, compiled by University of San Francisco business professor Mark Cannice, found a significant decline in confidence among venture capitalists in the second quarter of this year. Cannice said that implies a decrease in IPO activity in the third quarter.

“(Venture capital) confidence tends to precede a decrease or an increase in IPOs by one quarter,” says Cannice. “(Venture capitalists) tend to have foresight, as they need to work with investment bankers in advance of any IPO to secure a public listing for their portfolio firms.”

Volatile markets may also dry up venture capital funding, according to Mark Heesen, president of the National Venture Capital Association.

“Major issue is whether investors like pension funds, colleges, and endowments will continue to view venture favorably as an asset class and invest in (a venture capital) firm, which will then invest that money in emerging companies,” says Heesen.

At the onset of the previous crisis, venture capitalist investments fell 46 percent in dollar terms in the first quarter of 2009 versus third quarter of 2008, according to data from the National Venture Capital Association (NVCA).

Some experts also believe that highly anticipated deals from companies such as coupon website Groupon and online game maker Zynga may now be in danger.

“We are starting to see questions about the sustainability of some of the prime candidates for IPO transactions in the immediate future,” says Lee Graul, partner in the Capital Markets Practice of BDO USA. “Those questions, along with the volatility and uncertainty in the marketplace, may result in deferring any such IPOs for an indeterminate period of time.”

Francis Gaskins, president of research firm IPO Desktop agrees: “The market drop will motivate investors to step back and look at the asset class of Internet-subscriber stocks as a whole, and realize that it is not the best thing since sliced bread.”

Gaskins says Gropon, Zynga and even Facebook might have missed their IPO window.

“When a downturn hits, investors look at the companies that are able to IPO in a negative climate,” Gaskins told CNBC. “Those companies need to show top line revenue growth, they need to be profitable, and they need to be generating positive cash flow.”

“It means that Groupon, if it (goes public), will see a very significant drop in valuation,” says Gaskins. “So will Zynga and even Facebook.”

But the NVCA's Heesen disagrees.

“These companies have strong investor interest, investment banks clamoring to be part of the IPO, and research analysts are willing to track them," he said. “[The] majority of IPOs, however, don’t have all of these attributes and will have a harder time in uncertain economic and political environment.”

The IPO calendar is currently empty. Only four deals priced in August so far, setting it on pace to be the slowest month for U.S. IPOs since July 2009, according to Dealogic.

A slew of firms withdrew or postponed their offerings this month due to “unfavorable market conditions.” The only company that made it out this week, China’s online video website Tudou , fell below its IPO price right at the open and is now trading down around 28 percent.

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