Credit Crunch Stymies Funding for Start-Ups
By Tom Ryan
On its op-ed page, the Wall Street Journal last week questioned how the next Intel, Google or Apple will be funded given the ongoing liquidity crisis. But the retail industry faces a similar question: Who will fund the next Whole Foods, Amazon or Lululemon?
The piece by James Freeman noted that the second quarter marked the first time in 30 years that not a single company backed by venture capital went public in the U.S. Even before the credit crunch, venture-backed IPOs in 2005 and 2006 were far below the levels of the early 1990s. A recovery in IPOs in the early months of 2007 wasn’t close to the number of young companies being acquired by bigger, more established firms.
Although being acquired by a larger competitor certainly offers a funding option, Mr. Freeman wondered if the tech darlings would have prospered under different ownership. He speculates about possible fallback marriages such as Yahoo buying Google before its 2004 IPO or even IBM snapping up Intel before its 1971 IPO.
“An IPO generally means that the founders can continue to run the companies they have painstakingly built, except with greater resources,” wrote Mr. Freeman. “An acquisition generally means that the founders move on, see projects they championed get axed, and watch old colleagues get fired. How many company founders would aspire to conduct a sale of the business instead of a public offering, absent some bizarre and unnatural conditions in the market?”
While never attracting the level of capital flying to tech, retail start-ups are also likely seeing more limited funding and IPO options that had paved the way for IPOs from the likes of Best Buy, Kohl’s, Walgreens, Lowe’s, Bed Bath & Beyond and others in the past.
The problems finding funding from venture capital firms are being compounded by the reluctance of start-up companies to deal with the costs, liabilities and newer burdens of going public. “The [Sarbanes-Oxley] and governance issues are cumbersome, and it means they spend all of their time as administrators versus growing their companies,” Kate Mitchell of Scale Venture Partners told the Journal.
Also making IPOs less appealing for younger companies is the reduced coverage of small-cap companies by Wall Street due to increased regulations over investment banks.
In all, Mr. Freeman believes the challenges of funding and being public are robbing corporate America of much of its entrepreneurial drive
He concluded, “Our society should be encouraging these entrepreneurs to dream big.”
Discussion Questions: How much do you think funding for promising retail start-ups will be affected by the credit crunch? Do diminishing prospects for blockbuster retail IPOs diminish prospects around the development of blockbuster retail concepts?
In an interview detailing Ocado’s success in the UK (a successful home-delivery grocery business which supplies products from Waitrose, one of our better chains, albeit much smaller than Tesco, Asda, Sainsburys and Morrisons), founder and head of finance Jason Gissing says, about going public, “Personally I can’t think of anything worse to do. I am finance director and marketing director and it is a thankless task to be finance director of a public company in the UK. One day it will float, but I won’t be the finance director.”
http://www.guardian.co.uk/business/2008/jul/21/supermarkets.retail
This is, in my opinion both as customer and retail guru (yeah, yeah, yeah, that is meant to be funny, guys), an excellent business deserving to succeed and I think Gissing is right not to want to do an IPO. One of the reasons John Lewis, its major shareholder, has always been successful is its private ownership/partnership model. It is an example from which I think Ocado has and can learn a great deal.
Capital does exist out there. A ton of it is on the sidelines waiting for the right opportunity. For a retailer who is looking to crank it up, they need to do a road show. They need to get out, meet with people, tell their story, and push hard to raise funds. For the right deals, the money is available.
People with capital are going to take less risk for a while until this recession rides out of town. Unless some start-up company can produce a car that really gets 80 mpg, most IPOs are going to have to do it themselves.
Times are tough, but they always get better.
I’ve come to believe that we’re entering a period where many new successful retailers will be smaller format, micro niche ventures. Their growth will be more organic, as they go through their gestation stage. Their initial funding requirements will not be as great, allowing them to initially establish their business models without large infusions of venture capital. If this plays out, it will dovetail well with an investment community which is likely to remain cautious, even after the overall environment begins to turn around.
If you believe that the current economic slowdown is cyclical (even if it drags on for awhile), it’s also likely that there is a lot of capital sitting on the sidelines (fixed income and cash) instead of being invested in the equity market. At some point investors are going to see the merits of putting money back into stocks. So the lack of IPOs during the current quarter shouldn’t be seen as a permanent problem. There will always be innovators with profitable ideas, market niches and strong brand identities able to attract IPO investors.
Funding might be a little bit scarce for a few years as it was at various times in the 70s, 80s, and even early in the 90s. However, the economy will work itself out and funding will be available for good ideas, the right expansion, and for business planning that makes good sense.
Never underestimate the power and timing of the entrepreneurial dollar when facing a truly blockbuster idea. The challenge will be creating blockbuster ideas in an arid economic climate.
Less capital for retailer expansion means the remaining retailers can be stronger: less competition. Unexpected negative events wipe out too many overleveraged companies, and retail firms are often the poster children for leverage. In America, anyone over 21 can sign a lease and they’re a retailer. They can get supplier credit and lease their systems and fixtures, too. For every Amazon that was financed and became profitable, there were thousands who were financed and lost all their capital.
Furthermore, although venture capital firms can help retailers grow, they can also destroy them. Retail CEOs and CFOs have enough to do managing their businesses, yet certain venture firms demand so much constant attention that they impair their executives’ functioning. Venture capital firms want fast growth, and the speed often damages the retailer’s health.
Additionally, private funding sources have grown tremendously. After calculating the costs of going public and operating a public company (Sarbanes-Oxley, SEC regulations, etc.), it’s often a better idea to stay private.