With IPOs at lowest level since 1977, firms run out of options
— -- First Wind has big plans, and they involve getting listed on the Nasdaq Stock Market.
On July 31, the developer and operator of wind farms filed to sell stock to the public on Nasdaq and raise $450 million to pay off current investors and help finance future wind power projects.
The problem is that the market for IPOs, or initial public offerings of stock, has virtually shut down. First Wind hasn't announced any plans to cancel its offering, and declined to comment. But so far this year, 86 IPOs have been canceled, and there were only six new stock listings from venture-backed companies, the lowest since 1977.
"This is unprecedented," says Mark Heesen, president of the National Venture Capital Association, an industry organization.
In total, 43 IPOs have been priced so far this year, down 84% from 272 last year, says Renaissance Capital. It is also the lowest number since 1977, when 35 IPOs were offered, says University of Florida professor Jay Ritter.
The frozen IPO market has a cascading effect that could prove costly in a recession, where jobs are fast evaporating. A major avenue for private equity and venture capital funds to cash out has disappeared. That has forced the firms to hold companies in their portfolio longer than they would like, leading to a logjam of funding. It will affect both start-ups and companies in their latter stages that need cash to remain in business, leading to fears of a rise in bankruptcies of those that need a lot of capital to function.
Trouble cashing out
"Not only can't we harvest liquidity from IPOs and return money to our partners, but we then don't have enough money to commit to new ventures," says Trevor Loy of Flywheel Ventures in Santa Fe. "The bird that should be ready to fly off the nest stays there taking up more of our resources."
Consider Venrock, the venture capital firm backed by the Rockefeller family, which has had a hand in the early stage funding of companies such as Apple and Intel. Back in 1998, the firm invested $2 million in an upstart data-networking company named Anda Networks.
Over the years, Venrock plowed in more, and Anda became one of the older companies in its portfolio, generating revenue of more than $20 million in 2007. Anda filed in December 2007, hoping to go public this year. Ten years into its investment, Venrock wanted to cash out. But the financial turmoil hit, and Anda canceled its IPO. "As an early stage investor you hope to get liquidity in a five- to seven-year time frame, and 10 years is outside of what you would like," says Bryan Roberts, managing general partner at Venrock.
With so many IPOs shelved, there are fears that the lack of financing available could jeopardize the future of innovation in the U.S. "The last thing we want is clogging of the innovation pipeline, which is already under stress," says Heesen. "Entrepreneurs fund a start-up by initially taking out a second mortgage on their house, credit cards, and friends and family." However, almost all of those avenues have shut down right now.
The slowdown in the creation of new companies will also lead to fewer new jobs. According to a 2007 IHS Global Insight study, venture-backed companies accounted for 10.4 million jobs and $2.3 trillion in revenue in the U.S. in 2006. "For anybody who invests in an entrepreneurial venture, it's a leap of faith, and when confidence evaporates, that's a hard thing to do," says Josh Lerner, investment banking professor at Harvard Business School.
Stock market all stopped up
The stock market has traditionally been a great place for private companies with a small group of owners to get a return on their initial investment. Through an IPO, the public gets to participate in the growth of a company, which in turn gets access to a broader base for capital.
"It's a great way for management to compensate employees with stock options," says Kathleen Smith, principal and founder of Renaissance Capital, an IPO research and money management firm in Greenwich, Conn. "When these companies grow, they can also make acquisitions with stock," says Smith.
What's most worrying today is that the stock markets' "unwelcome mat" could put some new companies in financial straits. Especially vulnerable are those that require a lot of capital, such as alternative-energy companies. In the last couple of years with gas prices hitting record levels, solar, wind and biofuel energy companies have been hot investments.
This year, too, has been a record year for these companies, with $20.6 billion flowing in from private equity and venture capital funds through the third quarter, compared with $19.6 billion in the same period of 2007, according to New Energy Finance, which tracks the industry. However, energy prices have plunged, so new investment in this sector will be selective.
"Some companies will go out of business, and not all companies that were started will see through to fruition," says Steve Bird, general partner at Focus Ventures.
That's not good news for First Wind, which reports that its total expenditures rose to $40.3 million in 2007 from $22.9 million in 2006. And as it installs more wind farms, costs will go up even more. In its public filing, First Wind says: "If we are unable to obtain additional debt or equity financing, we may have to curtail our development activities or be forced to sell assets."