Where are the Exits going?

This month NESTA published their annual report into Venture Capital. Titled “Now and After the Dotcom Crash”, what can we learn about how the environment for Business Angel investment has changed? How has the market changed? And have Business Angels’ expectations changed to match?

Matthew Mead, the Managing Director of The National Endowment for Science, Technology and Arts (NESTA) Investments introduces their annual report which has the following conclusions:

  • Fundraising in 2009 was the lowest seen in the last decade. Over the last two years activity has dropped 40% with 40% less exits and 50% less money raised for VC funds.
  • Public funds are supporting investment. 56% of early stage deals had public backing.
  • Time taken to successfully exit is getting longer. The average time to exit through flotation or acquisition is now 7.5 years, the longest time for two decades.
  • Companies are requiring more rounds of funding before reaching the exit stage. In 2001-2003 companies raised an average of £10M in three rounds by 2007 this has changed to four rounds raising just £8M.

So what are happening to those exits? In short, they are getting further and further away.

The reduced VC activity (both in number of deals and funds available) reduces the likelihood that an Angel can depend upon future support from a VC or exit some money when the VC joins the company. That means more BAs will have no choice but to stay until the successful exit. Further, the exit is going to be more investment rounds away with each round resulting in a greater dilution of the original investment. Each round is going to be (on average) smaller… And worse still, the potential exit deal is getting further away into an uncertain future.

I was surprised by the quantity of public funds used to support early stage companies. This is a two edged sword. On the one hand it reduces the number of deals that Business Angels could get involved in (they are crowded out by the state). If (when) the state retreats there are more potential deals available but little experience on their management in the Business Angel community. On the other hand, some deals would never happen if the state’s money were not available. I’d like to know how this compares with other countries both in terms of quantum and successful exits.

NESTA scrabbles around for some good news: “Business Angels have partially stepped in” to cover the funding gap. This is expanded by saying the “Actual number of BA involvement in VC deals decreased in 2009 following the overall trend in the market”. So actually Business Angel Investment has fallen away at the same pace as VC Investment!

Despite the hard data, NESTA’s report is optimistic and positive saying “the fundamentals of the UK venture capital market appear to be sound”. Personally I think we are seeing a gradual return to normal business conditions after the irrational exuberance of the last two decades. The wise Business Angels need to compensate by changing their investment criteria… reduced valuations? Greater due diligence?

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