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A Cringing Quarter for Venture Capitalists

As I reported Saturday, venture capitalists experienced a very poor second quarter. The industry’s trade association said Tuesday that for the first time since 1978, not a single venture-backed company went public in the quarter.

From the perspective of the venture capital industry, it turns out that the news was worse than I reported.

The other bad news was the industry’s disclosure early Monday morning that acquisitions of venture-backed companies are down sharply too. In the second quarter, 50 merger and acquisition deals of venture-backed companies were completed. That’s down from 70 in the first quarter.

In the first half of 2008, there were 120 such deals altogether, down 28 percent from the 169 in the first half of 2007.

If you’re a venture capitalist, or a limited partner investing in venture funds, this is the part of the article where your teeth start to hurt and your temples throb. That’s because venture capitalists have looked upon the opportunity to sell their companies through acquisitions as an alternative, albeit a less lucrative one, to going public.

And now the merger and acquisition track has slowed too.

The National Venture Capital Association, the industry’s trade group, largely blamed a weak economy for the trouble its members are having finding profitable exits. But it said the government is to blame too, particularly for the dearth of initial public offerings. Were it not for excessive regulation in the form of Sarbanes-Oxley, it would cost less for companies to go public and there would be more offerings, the industry group said.

It said that in 2007, the median age of a venture-backed company from founding date to public offering hit a 27-year high of 8.6 years.

In a press release, Mark Heesen, president of the N.V.C.A., said the problem needs to addressed by policy makers or the results could be serious for the economy and innovation.

“Venture-backed companies that successfully enter the public markets represent a critical job creation engine for the United States economy, and that engine has completely shut down,” Mr. Heesen said. “We need to put regulators, legislators, presidential candidates, and the private sector on notice that this situation represents a serious problem that will have long reaching economic implications if not addressed. We view this quarter as the ‘the canary in the coal mine’.”

Some venture capitalists, as I noted in Saturday’s story, blame the industry itself, arguing seed investors haven’t been investing in the right kinds of startups if they hope to get the attention of Wall Street. Too many Web 2.0 companies, these critics say, were given money and not enough big growth, scalable, mass market companies.

Regardless of the reasons behind it, the timing of the rough quarter is inopportune for the industry, and not just because venture capitalists require public offerings or acquisitions in order to profit and get new investors filling their coffers. Mr. Heesen and the industry overall has been intensifying its lobbying efforts in Washington, trying to wield influence on such matters as tax and alternative energy policy.

But if the venture capitalists aren’t thriving and getting exits, it could begin to undermine the argument they make on Capitol Hill that they deserve a seat at the policy table because they are essential to job creation. In that respect, the difficult second quarter could be part of a vicious cycle for venture capitalists: they have trouble finding exits, they ake less money and then lose some of the clout they need among policy makers whpm they need to spur public offerings anew.