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Why Venture Capitalists Are Bearish on 2013

Suzanne McGee, The Fiscal Times
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The old year – 2012 – will go down in the record books as a good one for investors, as the S&P 500 eked out a double-digit gain of 13.4 percent. But to remind ourselves of the volatile and uncertain path that brought us to this point, and to give us more insight into what might lie ahead, perhaps it's better to delve into the world of the IPO market, and the views of venture capitalists and CEOs of startup companies still hoping to take their own businesses public in 2013 or beyond.

(Read more: 2013 to Bring Slim IPO Pickings)

The IPO market shows just how readily spooked investors could be in 2012. As the IPO specialists at Renaissance Capital noted in their year-end review, proceeds were at their highest level since 2007, before the financial crisis hit – but that was largely due to Facebook's outsize offering. And by the time bankers pinned a final valuation to the Facebook IPO, storm clouds already were gathering on the horizon.

Already-jittery investors seized on the botched deal – overpriced and bungled when the Nasdaq exchange couldn't cope with the initial flurry of orders – as a sign that they should dial down the amount of risk in their portfolios and shun companies making their public market debuts. As a result, the IPO market froze solid for about a month, and when it resumed activity proved spasmodic and readily derailed by news of everything from the ongoing debt crisis in Europe to the apparently futile negotiations to avoid the so-called "fiscal cliff."

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Indeed, all of the top-performing IPOs of 2012 were priced before Facebook arrived on the scene – and none of them were household names of the same kind as the social media giant. HomeStreet soared 115 percent over the course of 2012, after going public in February. GuideWire Software, one of the year's cluster of successful enterprise-software offerings favored by investors opting for proven business models over Facebook-style buzz, ended the year up 70 percent.

As of mid-December, according to data from Dealogic, the average 2012 IPO was up 14 percent, but that figure masks a large number of disappointments, as well as the fact that no single sector was clearly leading the way higher. Top performers, as tracked by Renaissance Capital, included technology, health care, financial and business services companies. And the final two months of the year turned out to be the second-slowest on record since financial crisis.

The picture this paints is one of uncertainty. The Facebook IPO may have been the biggest venture-backed deal of its kind ever, but if you exclude that, Renaissance Capital noted, VC-backed IPOs were down 16 percent in number and 43 percent by the amount of proceeds raised. That can't be encouraging for venture investors, even as the IPO pipeline continued to grow in the second half of the year. One (anonymous) startup CEO, asked by the National Venture Capital Association for his thought on the environment for the new year, responded succinctly: "More of the same. Difficult environment to raise private capital. Difficult IPO market. Very few companies will be started."


Adam Gault | OJO Images | Getty Images

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It hasn't helped that investors have been steadily pulling money out of actively managed mutual funds, which tend to be a primary source of capital upon which bankers can draw when bringing a company public. Instead, those investors have opted for investing in exchange-traded funds (ETFs), tied to indexes that tend to be made up of established stocks. That's particularly true of the most liquid and most favored ETFs, linked to the S&P 500 and other well-known indexes. On the margin, a fund manager aware that investors are more skeptical about his or her ability to beat the index, and conscious that investing in newly public companies is a more risky if potentially more lucrative endeavor, may steer clear of all but the most blue-chip of IPOs.

The result? An increasingly bearish view of 2013 on the part of the venture capital industry. Only 27 percent of venture investors expect to increase the rate at which they invest, while a large majority of the portfolio companies surveyed by the NVCA say they will be expanding their operations; 47 percent of venture funds in the survey say they expect to invest less in 2013. Both groups believe that consumer technology companies will find it harder than ever to obtain capital, and that early-stage capital will be the hardest of all to find. Those startups that do get funded will find that the terms favor their venture investors, survey respondents agreed. And only 7 percent of the companies surveyed believe an IPO is in their future.

This is one of the most upbeat and optimistic groups of CEOs and investors in the country – indeed, being a venture capitalist or running a startup requires as much unquenchable enthusiasm as it does hard-headed pragmatism. Even if Renaissance Capital is correct in its prediction that we simply aren't seeing some of the potential IPO activity because it is sinking into a de facto shadow market thanks to the passage of the JOBS Act (which enables companies to raise money from the general public without filing for an IPO with the SEC), the attitudes tell us just how great the uncertainty has become.

Finding a way to contain the damage that might be done to the economy and to the standing of the United States in the eyes of its trading partners by a final step off the edge of the fiscal cliff would be one positive step to restore confidence not only to financial markets in general but to this segment, which serves as a kind of leading indicator. But the story behind the year-end data suggests that caution may be the watchword throughout the financial markets for 2013.

-This piece originally appeared on The Fiscal Times.