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Update on Private Capital Markets: Is the Recovery Slow and Steady or Stuck?

Jim Nolen, a distinguished senior lecturer in the Department of Finance at McCombs, offered his take on the prevailing state of affairs in the public and private equity markets during a Knowledge To Go webinar on July 12. He discusses the state of current markets, government intervention and the future of IPOs.

Current capital markets:

1. Banking
Nolen suggests that small banks’ lending remains sluggish because of continued regulator concern regarding real estate and consumer loans. He says “larger banks are loosening credit faster than small banks but total loans on U.S. banks have declined for 11 quarters,” even with an uptick in the last three quarters on commercial loans. Nolen believes that small banks’ loan losses haven’t peaked and that the number of new loans will continue to fall.

2. Mezzanine Debt
According to Nolen, mezz funds are making a comeback. He says some of the funds “are competing with venture capital as a cheaper source of growth equity capital with fewer strings and governance issues.”

3. Angel Investing
Angel investing is improving with total investment up more than 14 percent from 2008-09. Angels have moved away a bit from their typical seed/start-up funding, with that stage down 4 percent. Nolen also says “that some of the increase in dollar investing can be attributed to the rise of the Super Angels, who are backfilling the void of seed/start-up funding by traditional VCs.”

Jim Nolen4. Venture Capital
According to Nolen, venture capital investments have declined overall since the dot-com era but are beginning to rebound some. The first quarter of 2011 saw a substantial increase in venture capital deals over the 4th quarter 2010. Nolen says seed and early stage deals have picked up lately, but this group of investors continues to favor later stage funding to more mature companies. Internet and software saw a decrease in venture capital investments during the 1st quarter 2011, with cleantech, biotech, and medical device industries ranking first, second and third, respectively.

“The first quarter marks the strongest quarter for US venture capital fundraising since the third quarter of 2008,” reports Nolen. But he believes fund raising is still presenting challenges for investment banking firms, with the big firms still having the most success.

5. IPOs and Venture Capital Exits
IPO activity was off in the first quarter of 2011 but rallied in the second quarter. According to Nolen, the good news is that IPO activity in the second quarter grew “at the fastest pace since Q2, 2007 and included some high profile and social networking companies.” 

But he cautions that times are still tough. IPOs are still difficult for non name-brand companies. With the relative dearth of IPOs, venture capital buyout to exit times are longer. “M&A continues to be the primary exit vehicle of VCs,” says Nolen. “Generally valuations are lower for M&A than IPOs thus hurting VC returns.”

He does, though, expect a flurry of deals in the near future because so much venture capital is waiting to exit investments.

Near-term government actions and their effect on the shaky economy:

Nolen also has some concerns about the health of the stock and bond market after the end of QE2, but he says, “Technically the Fed is reinvesting about $20 billion in maturing bonds monthly so it will not be cold turkey.”

He says that another looming problem is the possibility that Congress will fail to increase the debt ceiling and “default on its obligations or be downgraded from AAA.”

Another Tech Bubble or Improved IPO Market:

Nolen offers that “like the dot-com bubble, many of the companies going public (Groupon, Pandora) are unprofitable and are using metrics like growth of uses to justify their valuations. Other companies are showing a small profit but are trading at ridiculous multiples and revenues and earnings (LinkedIn, Open Table).

But he also believes that while some companies are overvalued, “most people are too concerned about macroeconomic and geopolitical issues to create a huge bubble.” His hope is that companies like Facebook, Groupon, LinkedIn, and Zynga will play a part in improving the U.S. IPO market and venture capital investment activity.

Visit the Knowledge to Go section of our alumni website to listen to a full recording of the talk, view Nolens' presentation slides and register for upcoming webinars.

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