Foley Survey Reveals Signs of Optimism, Lingering Challenges Among Emerging Technology Executives

Fifth-Annual Survey Finds Executives Looking to M&A Market for Survival and Tailoring Growth to Strategic Buyers; Fallout in Number of Investors Enduring through Dismal Returns.

Emerging technology companies and investors continue to face a challenging business environment, but are seeing signs of optimism, according to a national survey conducted by Foley & Lardner LLP. In contrast to the overwhelmingly pessimistic outlook for emerging company valuations and access to capital in 2008, emerging company executives, advisors and investors are now starting to see a sliver of light at the end of the tunnel. The highest number of respondents in five-year survey history (72 percent) now expect emerging company valuations to grow over the next two years. This represents a significant increase from the 38 percent who predicted growth in 2008 and is similar to levels seen during the fairly healthy economic environments of 2005 and 2006.

After witnessing the largest percentage of respondents in survey history with no intention to sell in 2008 (17 percent), executives are once again exploring opportunities for an exit. Only 12 percent of respondents to the 2009 survey indicated having no intention to sell and although the majority of executives (72 percent) anticipate being three or more years from an exit, this is a decrease from 2008 (81 percent) and is moving closer to 2006 levels.

“Although emerging technology companies continue to face numerous challenges in the current market, more hopeful predictions for access to capital and valuations indicate we’ve reached the bottom of the market,” said Gabor Garai, chair of Foley’s Private Equity and Venture Capital Practice. “Emerging company executives are cautiously optimistic about available exit strategies and we’re seeing anticipated timeframes for an exit moving closer to 2006 levels, which was within a fairly robust economic environment.”

Entrepreneurs Look to M&A Market; Seek “Survival Capital”

Since the 2005 survey, the number of emerging company executives citing a merger or sale as their likely exit strategy has decreased consistently. This year’s survey saw the first uptick in executives planning a merger or sale (61 percent), representing an 8 percent increase from 2008. Furthermore, 21 percent of respondents indicated accelerating a planned merger or acquisition, up from 11 percent in 2008.

“We attribute this data to a cash flow issue,” Garai explained. “Companies in distressed situations are increasingly looking to the M&A market as a survival strategy as they lack the capital to stay afloat in the current economy.”

Surprisingly, the 2009 survey saw a nine percent increase in companies who have sought or obtained capital in the past year (70 percent). As companies continue to struggle in the current market, executives seem to be seeking capital for survival, as opposed to growth, as a necessity to survive this cycle and exit when the economy recovers.

Strategic Buyers Exert Strong Influence

As opportunities for an exit remain limited in the current economy, executives are overwhelmingly tailoring their growth to fit the expectations of strategic buyers. The vast majority of respondents (77 percent) agreed that the business plans of today’s emerging companies are influenced by the known needs of strategic buyers and 71 percent of responding executives are tailoring their growth to strategic buyers.

“Consistent with the numerous strategic acquisitions of emerging tech companies that we’ve witnessed in recent months, respondents clearly acknowledged the presence and impact of strategic buyers in today’s market,” said Susan E. Pravda, Chair of Foley’s Emerging Technologies Industry Team. “With the majority of responding executives planning a strategic exit, the private equity and IPO markets, which have been driving exit strategies over the past few years, are likely to be less common. It will be interesting to see how the prevalence of strategic buyers shifts next year if the IPO market becomes more robust and liquidity expands.”

Investor Community Reaches “Survival of the Fittest” State

Investors who have experienced success are continuing to actively raise new funds, whereas others are choosing to walk away from the market. While half of the responding investors expect to raise a new fund within the next two years, the number of investors indicating they will not raise a new fund has increased dramatically from 2006 (5 percent) to 2009 (44 percent).

“This finding is indicative of a fundamental shift in the venture capital paradigm,” Garai explained. “We’re witnessing a fallout in the number of VCs who will survive through a market of dismal returns as some are not willing to risk further investment in the current market.”

IPO Market Not Yet Viable Exit Strategy

Similar to previous years, virtually no emerging company executives surveyed (3 percent) plan to test the IPO market. However, respondents expressed some optimism in their outlook for the IPO market. 13 percent of respondents anticipated a robust IPO market over the next two years, in a significant increase over the 1 percent who felt this way during our 2008 survey. Similarly, the percentage of respondents predicting a declining IPO market dropped from 36 percent in 2008 to 6 percent in 2009.

“We see the predictions for the IPO market expressed in this year’s survey, combined with recently announced IPOs, as a sign of optimism,” Pravda explained. “The expectations for the IPO market in this year’s survey are similar to levels seen during our 2005 survey, at which time the economy was fairly healthy.”

The survey, conducted in September 2009, was completed by 230 emerging technology company executives, investors and advisors.

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