With the broader economy sputtering, venture capital firms are finding it increasingly difficult to generate returns through the sale or public listing of portfolio companies. In the second quarter of 2008 there were no initial public offerings (IPOs) of U.S. venture-backed companies. Moreover, liquidity generated via mergers and acquisitions (M&As) fell to $4.7 billion with just 56 transactions completed, according to the Quarterly U.S. Liquidity Report released by Dow Jones VentureSource.

"The U.S. venture capital industry is in the midst of the second-longest IPO drought we've seen since we started tracking the industry in 1988," said Jessica Canning, Global Research Director for Dow Jones VentureSource. "The last completed public offering for a VC-backed company was in March and we've seen 10 companies withdraw IPO registrations since then. Even though there are currently 22 venture-backed companies in IPO registration, it's clear they're in a holding pattern and waiting for market conditions to improve."

In terms of overall liquidity, which includes both IPOs and M&As, the second quarter's $4.7 billion marks a 47% drop from the same period last year.

M&As: Down Across the Board

The Dow Jones VentureSource report shows that the second quarter's 56 M&As mark the fewest number of transactions completed in a quarter in at least a decade and well below the second quarter of 2007, which saw $8.8 billion generated via 97 M&As.

While acquirers were paying a median of more than $55.8 million for venture- backed companies in the second quarter last year, the median amount paid for a venture-backed company in the most recent quarter increased 57% to 87.6 million.

"The broader pull-back in the economy is affecting corporate spending and is clearly impacting the M&A market," said Ms. Canning. "Corporations might be out looking for venture-backed companies to acquire but many are either doing so quietly or choosing to hold off on entering into negotiations. This, coupled with the closed IPO window, is putting downward pressure on acquisition prices."

Information technology (IT) companies accounted for the bulk of capital raised via M&A in the second quarter with 41 transactions generating some $3.3 billion in liquidity, a hefty 29% drop for the segment from the nearly $4.6 billion raised in 61 M&A transactions during the same quarter last year. By sector, software companies accounted for the majority of IT deal flow with 28 M&A transactions garnering nearly $1.2 billion. The largest deal of the quarter was Time Warner's $850 million acquisition of the San Francisco-based online social networking company, Bebo.com.

According to the data, only six venture-backed health care companies completed M&As in the second quarter, raising just $267.8 million, some 86% less than the $1.9 billion raised in 16 M&As for the segment in the second quarter of 2007.

With its nine completed M&A transactions amounting to roughly half of last year's second quarter total of 17, the business, consumer and retail industry accounted for $1.2 billion in liquidity, well below the $2.2 billion generated via M&As in 2Q07.

To make matters worse, it took venture capitalists more time to steer these companies to M&A. The median number of years between initial equity funding and exit via an M&A now stands at a record seven years. The median amount of venture capital raised prior to liquidity remained fairly steady at $21.3 million.

"We're at the mercy of the market right now," added Ms. Canning. "Unfortunately, we're just going to have to wait and see if the liquidity markets recover in the second half of the year."