Strategies for a discontinuous future.

Monday, January 30, 2006

Disrupting VC

For all the talk about disrupting VC with CMGI-style publicly traded vehicles, I think the real point has been obscured - Peter Rip nails it when he says that the days of the Big Exit are gone (at least for now).

Now, this begs the deeper question: what's going with the IPO window?

It's been gradually opening. But, in fact, while it's opened, what's happening seems to be that there's little liquidity for VC-backed plays in particular. Let's run a few numbers.

In 05, on the American markets, there were 56 venture-backed IPOs out of a total of 202 IPOs; roughly 1/4th of the market, for a total of $4.5 bn. The total return was ~18%.

In 04, there were 93 venture backed IPOs out of total of 216 IPOs, for a total of $11 bn. The total return was ~35%.

What's a "normal" number of IPOs? Probably around 300ish.

Now, two datapoints do not a trend make; but there seems to be little appetite on the markets to trade capital for equity in venture backed plays, even while the IPO window continues to open. Even when venture-backed plays do list, they're often underpriced (from the VC/company's perspective).

Why? There are many reasons. Many VC-backed plays which should be ready for primetime often don't meet the absolute revenue/profitability measures that banks think investors need - they simply don't make enough money, or aren't profitable enough.

But that's changing; the bigger reason is pretty simply, that the excesses of the bubble have demonstrated to the buy side that VC-backed plays can be a very risky class of assets for the public to invest in. This is why new exit routes, which are historically more comfortable with (post) venture risk like AIM, are becoming (kind of) attractive - the kind of is because they can account for the risk semi-intelligently, and offer smaller returns.

And, of course, the biggest reason is simply that VC's aren't and haven't been investing in the right places - they've focused attention on either hugely volatile industries like biotech, or increasingly moribund ones, like IT.

So, IMHO, it's little surprise that the window is closed for VCs, because value creation is shifting to other spaces, like media, lifestyle, culture, the social etc. It's taken a veeery long time, but slowly, VCs are shifting their interest to these spaces - viz Polaris and Heavy.

Yes, I realize that VCs haven't traditionally invested in these areas because they're dominated by huge idiosyncratic risk, which is difficult to hedge. But perhaps the new name of the game is finding ways to achieve zero risk in these spaces...

-- umair // 9:38 PM //


umair -

I appreciate your optics on Liquidity events and how you tie their absence back to one of your central themes but i feel that in doing so you have overlooked a far more obvious reason as to why we are seeing fewer and fewer IPOs.

If the CMGi era (of which i am an alum by the way!) of cavalierism did one thing, it caused our government here to really gets its noise out of joint.

Comparable to the Telecom act of 1994(?) in significance, where unbundling of loops gave us ubiquitous and commoditized plumbing, Sarbanes Oxley or SBOX as it is sometimes referred to - turned off that gushing detritus of misconceived pump and dump activity and forced the constituent capital players to get real, get honest, or get lost.

Protecting street investors it has done - the reasons as to why are for another topic entirely - but the thundering hurd that traversed the plains of everyday american retirement assets, has now changed course.

Private Equity and hedge funds as an asset class now sit at about 1.8 Trillion under management. As a peripheral constituent that sucks of the hind tit of this behemoth, there are several key markers of change in a SBOX world:

1. It is now extremely hard to get public. (see the vonage S1 and ask how long that took - CMGi days we had S1's in print cue at kinko's)

2. It is now much less attractive to be an executive of a public company (see Lou getsner's interview in business week)

3. It is more frightening than ever banking offerings (see every bulge bracket settling for hundreds of millions on insider offerings etc)

4. It is much harder to convince an unsophisticated but highly jaded public of tech irrational exhuberence.

So - what does this mean? what are the liquidity alternatives for VC and Private equity asset classes?

Create your own marketplace away from such prying eyes. Sell to each other, finacially re-engineer balance sheets, change leverage, improve operating performance, consolidate, re-cap and on and on .....amongst each other.

Cue $22 billion blackstone fund. Cue 4 times more M&A amongst funds, Cue renewed focus on acqusition platforms, Cue billions and billions transacted between funds, away from uncle sam.

These financial vehicles have hit a critcal capitalization mass and have created liquidity amongst each other in an unprecedented way.
// mark slater // 5:40 PM
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