Venture Funding Shrinks Leaving Scores of ‘Walking Dead’ Firms

Stung by a drought in technology initial public offerings, venture capital investing plunged in 2010, with the number of active firms dropping 47 percent in the first half from last year, according to Ernst & Young LLP.

The number of U.S. venture firms making at least one investment a quarter sank to 167 through June from 313 in all of 2009, the accounting firm said this month in a report: “The Limited Partner Venture Capital Sentiment Survey.”

The decline in IPOs has led to deteriorating returns at venture-capital companies, making it harder for them to raise new funds. That’s created a class of “walking dead” firms that are only working with their existing portfolio companies and don’t have the cash to make new investments, said Bryan Pearce, Americas director at Ernst & Young, in Boston.

“It’s going to be harder for startups to raise money because there are fewer places to go,” said Pearce, who worked on the survey. For the struggling firms, “it’s a slow and painful death,” he said.

Pensions and endowments invest in venture-capital funds with the expectation that in a 10-year period the fund will buy stakes in startups and profit by helping them go public or get bought. That strategy, which paid off in the 1990s, has backfired during the past decade because of the bursting of the dot-com bubble and the more recent financial crisis.

Of the startups that venture capitalists first invested in during 2000, 61 percent have gone out of business or are still private, according to the report, meaning they’ve yielded nothing to shareholders. Only 2 percent of initial investments from that year were in companies that have gone public.

IPO Rebound?

IPOs have picked up this year, with 40 venture-backed companies going public through the first three quarters, compared with 18 in 2008 and 2009 combined, according to the National Venture Capital Association. The total is down from 2007, when there were 86 venture-backed IPOs, and is a fraction of the 264 in 2000.

Another survey, from law firm DLA Piper LLP, says that almost 64 percent of venture capitalists, entrepreneurs and technology executives don’t expect IPOs to return to where they were in the late 1990s and early part of 2000. Close to 60 percent of those executives say the venture model is “permanently altered,” according to the “Technology Leaders Forecast Survey,” being released by DLA Piper this week.

“If there is a long-term expectation that the IPO market will not rebound, that means a reduction in the number of dramatic home runs for venture-capital investors and lower overall returns,” Peter Astiz, DLA Piper’s global co-head of technology, said in the report. “Fewer IPOs also means fewer small- and medium-size public technology companies, which traditionally have been the acquirers from many of the technology company exits.”

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