Venture Capitalists Still Cautious

Things are finally brightening up on the depressed high-tech IPO scene. Two deals--language-software company Rosetta Stone and online college Bridgepoint Education--hit the market this week, and both rose on their first day of trading. Rosetta Stone's shares soared nearly 40%, while Bridgepoint's edged up 6%.

So Silicon Valley venture capitalists, who back tech and biotech start-ups, should be turning cartwheels, right?

Not exactly.

Though Bridgepoint is backed by private-equity firm Warburg Pincus, which does some smaller VC deals, the company is much larger than a typical venture-backed start-up: Revenues last year were $218 million. Ditto for Rosetta Stone, which was not backed by the VC crowd. The company had sales last year of $209 million--and, like Bridgepoint, has been consistently profitable.

Bridgepoint's deal also priced below its expected range. That indicated investors were less than thrilled with the company--though obviously enthusiastic enough to bring it to market. That in itself is a small victory in today's still-choppy markets.

It all makes these deals nice, but not exactly a harbinger of more VC-backed stock offerings. New Internet companies, start-up drugmakers or medical-device companies are still viewed as riskier for investors to buy and for bankers to take public. And right now, Wall Street just doesn't have much appetite for that kind of gamble.

The two IPOs this week "make me feel incrementally more positive," says Stephen Harrick, a partner with institutional Venture Partners. But investment banks are still hanging back when it comes to taking venture-backed companies public, he says.

The market for VC-backed deals has also been buffeted by more systemic factors, like the decline of small-stock research at investment banks and the switch to trading stocks in penny increments. That has shrunk profits at investment banks and cut back on the money available for research. Without good research, mutual funds and other big investors won't buy a stock.

The continuing lack of exits for VCs--who make money when the start-ups they back go public or are acquired by other companies--is trickling down to dampen enthusiasm for funding new companies. (If they can't make you money, why invest in them in the first place?) On Friday, the National Venture Capital Association and Thomson Financial said U.S. VCs put just $596 million into first-time financings, down 48% from the fourth quarter of last year.

Overall venture financing in the U.S. plummeted as well. VCs invested just $3 billion in 549 deals in the first quarter, the lowest investment level in 12 years. Even the once-hot "clean technology" sector took a hit: Clean-tech VC dollars, funding efforts like solar-panel manufacturing and biofuels, plunged 84% from the fourth quarter, despite all the hype over green energy from the Obama administration.

Building solar-panel factories and cellulosic-ethanol plants is a lot more expensive than sticking up a new social-networking Web site--hence even tougher for VCs to stomach in the current, risk-averse environment. VCs also probably funded too many of these companies, says Noubar Afeyan of Flagship Ventures, which created a crowded field from which even good companies had trouble standing out.

This week's IPOs for Rosetta Stone and Bridgepoint are, let's face it, good news. The fact that "people even opened their checkbooks at all has got to provide at least a glimmer of hope," says former VC and current hedge-fund manager Bill Burnham. But people shouldn't hold their breath waiting for a flood of VC-backed deals, Burnham says. The market will have to pick up appreciably before the gates truly open.