Foley Survey Reveals Continued Challenges for Emerging Company Executives and Investors

Sixth-Annual Survey Finds M&A Remains Top Exit Strategy; Ongoing Difficulty Raising Capital; Optimism in Hiring Plans and Outlook for Valuations.

While the business environment for emerging companies remains challenging, there are a number of indicators that reflect optimism among both emerging company executives and investors, according to a national survey conducted by Foley & Lardner LLP.

On the heels of very strong predictions for emerging company valuations in 2009, Foley’s sixth-annual survey of technology company executives, investors and advisors revealed even greater optimism in forecasts for the next two years. An overwhelming majority of respondents (83 percent) now expect emerging company valuations to grow, compared to the 38 percent predicting growth in 2008. However, despite optimistic predictions for growth, emerging company executives continue to experience a difficult financing environment with 45 percent extending their timeframe in an effort to raise capital and 39 percent seeking capital from alternate sources.

“Although emerging companies continue to face numerous challenges in the current market, clear signs emerged in 2010 that the economy is stabilizing,” said Gabor Garai, chair of Foley’s Private Equity & Venture Capital Practice. “Emerging company executives are facing a radically different financing environment and have had to adjust their strategic plans accordingly, however they are optimistic in forecasting their growth over the coming years.”

Quick, Safe and Small Trump Risky Bets with Potentially High Returns

The overwhelming majority of survey respondents (80 percent) indicted that investors prefer quick, safe investments and smaller returns, as opposed to risky bets on companies that could generate a significant return. “This finding is indicative of a fundamental shift in the venture capital paradigm as investors are less willing to take chances with risky investments and are instead focused on smaller, more predicable returns,” said Garai.

At the same time, nearly two-thirds of respondents (62 percent) stated that emerging companies are experiencing greater difficulty closing “B” round funds as opposed to “A” rounds.

“As investors focus on quick in-and-out companies and safer returns, we’ve witnessed a preference among some investors for ‘A’ round investments that require less capital, as well as late round investments (i.e. ‘C’ or ‘D’ rounds) that offer smaller, but predicable returns,” said Susan E. Pravda, chair of Foley’s Emerging Technologies Industry Team. “In today’s marketplace, the ‘B’ round is the tough one as it generally requires investors to commit more capital with the potential for only moderate returns.”

The 38 percent of respondents who felt ‘A’ rounds are more difficult to secure indicated in verbatim responses that investors are: “looking for an established revenue stream,” “protecting their ‘A’ round money” and “[expressing] little appetite for innovative ideas that need to have proof of concept established.”

Emerging Company Executives are Actively Hiring

Consistent with recent data revealed by several of the major accounting firms, emerging company executives surveyed are actively hiring and are optimistic in forecasting hiring plans.

A high percentage of executives indicted hiring both full-time (39 percent) and part-time (45 percent) employees in the last 12 months and nearly half (47 percent) expect to hire 1-4 full-time employees in the next 12 months. Interestingly, 31 percent of executives plan to hire five or more, with one respondent indicating plans to hire over 100 full-time employees.

“The optimism around hiring predictions is encouraging because it indicates a willingness to invest in business growth and emerging companies are widely considered to be a key engine for job creation in our economy,” said Pravda.

M&A Remains Primary Exit Strategy, Ongoing Influence of Strategic Buyers

Similar to previous years, the majority of executives (58 percent) indicated a merger or sale as their likely exit strategy. At the same time, respondents continued to acknowledge the influence and prevalence of strategic buyers in today’s market.

Consistent with data from our 2009 survey, the vast majority of respondents agreed that strategic buyers are more active than at any point over the past five years (68 percent) and emerging company business plans are influenced by the needs of strategic buyers (82 percent). Although 57 percent of emerging company executives agreed to tailoring their growth to strategic buyers, this represents a decrease from the 71 percent of executives who expressed agreement in 2009.

“As M&A remains the primary exit strategy, entrepreneurs are no doubt influenced by the needs of strategic buyers,” said Garai. “However, executives are not tailoring their growth and strategic plans to the same degree and, with the private equity market resurging, seem to recognize strategic buyers as one of many viable exit strategies.”

Optimism Creeps into IPO Market Forecasts

Although executives again indicated a reluctance to test the IPO market, with only 5 percent citing an IPO as their likely exit strategy, some optimism emerged in their outlook. Other recent surveys have revealed a steady increase in predictions for a robust IPO market over the next two years.

The survey, conducted in September and October 2010, was completed by 198 emerging technology company executives, investors and advisors.

Foley & Lardner LLP continually evolves to meet the changing legal needs of our clients. In a recent survey of Fortune 1000 corporate counsel*, Foley ranked first for superior client service and value. In addition, Foley was a Top 10 firm on the U.S. News – Best Lawyers^® 2010 “Best Law Firms” list, based on the total number of first-tier metropolitan rankings, and CIO magazine recognized Foley for technological innovation that enhances business value by naming the firm to its prestigious CIO-100 list. With nearly 1,000 attorneys in 21 offices and more than 60 practices, Foley is recognized for providing high-caliber business and legal insight. Our team-based approach, proprietary client service technology, and practice depth enhance client relationships while seeing clients through their most complex legal challenges.

*The BTI Consulting Group (Wellesley, Massachusetts)