Shutdowns Loom In the VC World

Britt Tunick

Many of the generation of venture-capital funds born at the height of the market boom face a life or death choice this year, as industry observers believe these funds will either be forced to consolidate their portfolios or close up shop entirely.
Funds from the 1999/2000 era “are going to have a very difficult time raising money going forward, principally because the typical institutional [limited partner] is still over-allocated,” said Tyler Wick, a principal with VC Ticonderoga Capital.

Looking ahead, he expects many of these funds will be unable to raise further funding rounds and will be forced to manage their existing portfolios through to the conclusion of their partnerships.

“You can’t run a business if you’re not getting any return and you’re not raising a second, third or fourth fund,” said Lucy Marcus, managing director of U.K.-based Marcus Venture Consulting, a consultancy for both U.S. and European venture capitalists and start-ups. “For those who’ve been stalling and who’ve been doing so by just sitting there with money and churning it for more than a year, I think that’s got to go.”

A large number of the first-time funds launched during the 99-‘00 period had major concentrations in such areas as early-stage technology, biotech and telecom companies, all of which have been slammed in the current recession. As new initial public offerings or M&A announcements are extremely rare, there are far fewer traditional exit opportunities for VC portfolio companies, with no relief anywhere on the horizon.

A key example is Optical Capital Group Ventures LLC, a Maryland-based VC that invests in cable and telephony communications infrastructure companies. This type of fund, due to its industry specialization, will likely feel the most pain, and may be forced to merge some of the companies within its portfolios with those of other VCs. Optical did not return calls by press time.

VCs that will face the most serious trouble this year are those with funding in the neighborhood of $30 million. Beyond size, bankers said other features of a troubled VC include: funds that haven’t fronted any companies in quite a while; those who can’t afford to top off the struggling companies in their portfolios and that don’t have the credibility to draw additional funding from the marketplace; and even those with stronger companies that just can’t find near-term exit strategies and are facing eroding cash flows and management fees.

Though industry observers said a bit of consolidation has already begun among the smallest players, they expect the majority has yet to occur.

“You’re going to see a lot of funds either wind down, go into a sort of semi-activity state or be acquired,” said one former VC fund manager. “There’s always been a lucrative market in buying secondary venture investments and there are a couple of funds out there that specialize in those and will get some good deals.”
And while smaller funds will likely suffer worse than larger ones, size won’t necessarily be a savior. Fund managers said that even many of the larger funds launched during the dot-com bubble are starting to struggle, and that any fund whose limited partners consisted primarily of once-successful entrepreneurs could have a hard time calling down capital.

With so much grim news for the immediate future, which VCs are expected to best survive the inevitable crisis? Ticonderoga’s Wick said the best-positioned VCs are those that invested in companies that were either near or already at profitability, and whose companies are far less reliant on exit opportunities or follow-on rounds of funding for survival.

Wick said there is currently a backlog of venture-capital funding waiting on the sidelines for these type of companies-those that can demonstrate strong cash flow, strong business prospects and a history of growth. “We have seen a lot of investor interest in technology-enabled outsourcing services,” he said. These include payment processing services, preferred provider organizations that are technology-enabled and business models that have recurring revenues such as human-resource outsourcing-type companies.

Date

1 January 2003

Organisation

Investment Dealers' Digest

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