Venture capitalism is not what it used to be. The bountiful returns of the dotcom years are long gone and venture capital (VC) firms are now struggling to exit their investments via initial public offerings (IPOs) or mergers and acquisitions (M&A). Also, a new regulatory landscape is threatening to hinder rather than help the industry, and the companies VCs invest in require watertight strategies for major growth. VC experts highlighted these issues and others during a recent panel discussion sponsored by Wharton Entrepreneurial Programs and titled, "Business Exits in the Current Economic Environment."

Appropriately, the event was held at Wharton's campus in San Francisco -- on the doorstep of Silicon Valley, which generates about half of all VC investments worldwide and where venture-backed companies earn about $3 trillion in annual revenues and employ 12 million people, noted the panel's moderator, Wharton management professor Raphael (Raffi) Amit.

But regardless of where their investments are based today, no VC firm has been immune to the global downturn. The number of IPOs by venture-backed companies in the U.S. plummeted from 260 in 2000 to 13 in 2009, and VC-backed M&A transactions dropped from 462 deals worth $99 billion (in disclosed values) in 1999 to 260 worth $12 billion in 2009. Investors, meanwhile, have reduced their commitment to the industry, from $41 billion in 2007 to $15 billion in 2009 in the U.S., according to Amit, who was joined by Larry Sonsini, chairman of Wilson Sonsini Goodrich & Rosati (WSG&R), a law firm in Palo Alto; Ted Schlein, managing partner of Silicon Valley VC firm Kleiner Perkins Caufield & Byers (KPCB) and former chair of Virginia-based National Venture Capital Association; and Frank Quattrone, co-founder and CEO of Qatalyst Partners, a technology-focused investment bank in San Francisco.

Comparing Crashes

Among the issues explored by the panel was how -- or whether -- the much-anticipated recovery of the IPO market would be different from what took place after the dotcom crash. To help put the answer into context, Quattrone -- a former managing director and head of technology investment banking at Morgan Stanley and Credit Suisse First Boston -- reached back into history and looked at the technology IPO market of the 1970s. It was like "a backwater," he noted, with less than half a dozen companies going public each year. Despite IPOs from such future industry bellwethers as Intel and Tandem, the average deal size was around $10 million back then, he said. The market started gaining traction, however, with the IPOs of Apple and Genentech in 1980. In that decade, there were 32 technology IPOs a year, followed by more than 100 technology stock market debuts in the first half of the 1990s. From 1996 to 1998 -- the years that experienced the first wave of Internet-related IPOs as well as Amazon's IPO -- there were 240 deals annually, which were followed by the "crazy years" of 1999 and 2000, with nearly 400 deals a year.

As the VC industry picks up steam from its current state, it faces a markedly different environment than it did after the 2000 dotcom bust, according to Quattrone. After 2000, IPO activity was lean for a couple of years but then recovered. From 2001 through 2007, there were 62 deals a year and an average $11.4 billion a year was raised. In contrast, in 2008 and 2009 each, there were only 18 deals with a value of about $3.5 billion. In a sense, the recent deal levels are more or less reminiscent of the 1970s and 1980s, he noted.

Quattrone cited other factors that would make the current recovery different. For example, the dotcom bubble was focused on telecoms and the Internet and was "mostly a U.S. kind of phenomenon," he said. The damage was limited in large part to Nasdaq stocks, whose collective value fell some 80% between 2000 and 2003; the broader S&P index was down about 30%.

Big IPOs from the likes of Google and VMWare, and sufficient credit in the markets, helped VC fundamentals recover from the dotcom crash, as did the increased role of leveraged buyout (LBO) firms in IPO and M&A, according to Quattrone. LBO firms accounted for about 25% of the IPO and M&A markets in the mid-2000s, "buying big technology companies, taking them private and then taking them public again." However, "this time, [the crash] has been much deeper, broader, much more global," he noted. "The bust ... took 17 months to [force the market] down 50%, and it was down 50% not just in Nasdaq, but in the S&P, the Dow and most global indices."

The near-disappearance of credit is also striking. "It's really a 'have and have-not' market," Quattrone said. While each of the top dozen technology companies has $5 billion to $30 billion of cash and "a big advantage over the others," credit is largely unavailable to mid-sized companies. "It's going to take a longer time to come back.... We're going to need to get the credit flowing in the economy again before things really open up."

Of Risks and Rewards

The various players orchestrating the deals are also different from 10 years ago, the panelists noted. For example, there are fewer underwriters helping to take companies public, following a number of bankruptcies and a wave of consolidation. For those that are still in the game, risk-aversion is the new catchphrase. According to Quattrone, "The big VC companies now sort of have a chokehold on the distribution and they're not letting companies go public unless they have very, very large revenues and prospects for big market caps."

Sonsini -- whose law firm has been involved in such deals as Apple Computer's purchase of Netscape, Google's IPO and the HP and Compaq merger -- added that large investment banks today will not do an IPO under $75 million (bearing in mind that the IPOs of Cisco and Apple were under $50 million each). "The institutions have become so large, managing so much capital, that they really don't have time to pay attention to an IPO," especially a venture capital-staged IPO with less than $100 million in revenue and a market cap of less than $500 million."

The loss of independent research has also affected the market, Sonsini added, referring to former New York state Attorney General Eliot Spitzer, who forced investment banks in 2002 to separate research from their other activities, citing conflicts of interest in promoting IPOs. "That void has never been filled again.... The big banks have never found a way to make money by supporting independent research."

Indeed, the playing field among the banks is vastly different than before. Back in the 1980s and 1990s, big names like Morgan Stanley and Goldman Sachs each held between 5% and 10% of the technology IPOs, while the remainder was shared among "boutique" firms such as Hambrecht & Quist, Robertson Stephens, Alex Brown, L.F. Rothschild and Montgomery Securities. "The VC community was pleased to trust those [smaller] firms with book running some of their best offerings, like Sun Microsystems and Adobe," Quattrone said. "Today, it seems like the feeling is if Morgan and Goldman won't take your company public, it's not worth it. It's like saying, if you can't get your kids into Wharton or Stanford, they might as well work in the coal mines."

One solution, according to him, is to use this generation's boutique brokerage firms to lead smaller IPOs for smaller companies. "About half a dozen brokerage boutiques are perfectly capable of taking companies public and are willing to do smaller deals," he noted, pointing out that he didn't have an axe to grind since his firm does not do underwriting.

"[It] just comes down to some trust," said KPCB's Schlein, whose company is among the bigger VC firms. "The mid-bracket banks can get companies public ... [and] they can find buyers for the stock," although the offerings will be smaller. He recommended that firms look at a "two-stage offering." For example, the first IPO might be for $30 million, followed by another $30 million.

"Until we can get research in the system, until we can get more boutique banks to do smaller underwritings, until we can get institutional attention and get capital coming back, the risk-reward ratio [will continue to be] very difficult and you [will] have shrinkage of the IPOs," Sonsini said.