Musings on a barbarian's interests
Others have written about it, but for fun/work I put together a compressed version of how the global macroeconomic crisis we’re experiencing ties in with the IPO drought we’re experiencing and the related cracking of the VC model:
There are many accounts of our current global economic crisis – characterized by volatility, dislocation, and market failure – that lay out its historical antecedents and the resultant draught of credit and liquidity—including the specific failure of the IPO markets in the United States. In quick summary, the world financial markets have been shaken by a collapse of the U.S. mortgage market – especially in subprime – as these problems have destabilized global credit markets, previously inflated on uneven footing. Global productivity gains over the past 25 years and low central bank lending rates resulted in falling inflation and a low cost of debt. Easy credit fueled U.S. consumption and deficit-spending which, in turn, led to uptake of U.S. treasures as surplus-earning countries invested in these assets, and this demand in term restrained borrowing rates, thereby sustaining easy credit – the total value of which ballooned. Access to low-cost credit allowed an expanding base of Americans to purchase homes, and the resulting demand uptake sustained artificially high and growing housing prices. Accelerating this mortgage credit expansion was the design and distribution of a range of structured products – Mortgage-backed securities (MBS) as a simple example – that allowed default risk to be spread and fixed income rates to be distributed to those most willing to bear their underlying risk. When housing prices eventually started falling in the United States the music stopped — and credit markets froze. With no access to credit, significant mortgage default exposure and un-measurable counterparty risk, banks globally began to fail. These problems cascaded across the business ecosystem, hammering corporate incomes and leading to massive layoffs, further mortgage defaults and declining corporate and consumer spending, culminating in a continued downward economic spiral, the bottom of which we likely have not yet seen.
Even before this cascade became widely recognized, US IPO markets were already in trouble. Swept upward by the “tech bubble” of the mid-to-late 1990’s, the IPO markets skidded off-course between 2000-2002, as a threefold impact of the tech collapse, 9/11, and a series of corporate governance crises combined to constrain investor appetite for U.S. equities, undermined interest in still-developing business models, and fomented a set of regulatory overhauls that increased the cost of becoming and staying a public company. Down from their peak level in 1997-99 of hundreds of exits per year, the IPO markets started to recover in 2004-2007, but with the global financial crisis in full-swing, fell to their lowest level in years in 2008 – with only several dozen exits, of which only 7 were for venture-backed companies. Gone are the days when a company can reasonably expect to get to a public exit (IPO) within 5-6 years—dramatically changing the game for venture funds who had relied on speed-to-exit and portfolio-adjusted risk to support high IRRs and ever-enlarging funds, bequeathed by LPs eager to earn high returns. Along with this, traditional strategic acquirers – Microsoft, Oracle, IBM, Yahoo, and now Google – have tightened their belts, unwilling to deploy capital in a down economy. And as limited partners globally seek to rebalance their portfolios in the face of heavily-declining equity markets and a desire to get away from leveraged-based funds (LBOs), venture funds face redemptions that they can’t meet due to longer portfolio company holding periods. Returns are sagging, capital is skittish about piling into the venture fund class, and as a result a fundamental engine of American innovation – functioning capital markets for early-to-growth stage companies – is idling in neutral.