IPO malaise forces VCs to improvise – Brief Article

IPO malaise forces VCs to improvise – Brief Article – Statistical Data Included

Byline: Vyvyan Tenorio

Many venture funds that financed an abundance of IPO-delayed startups in the past two years are tapped out. Yet their portfolio companies need more money.

What to do?

In the latest VC financing twist, several prominent venture firms are raising supplementary funds to help ease those capital constraints.

Among them are Accel Partners, of Palo Alto, Calif., which is raising a $50 million fund, and New Enterprise Associates, of Menlo Park, Calif., which is discussing a similar fund with its institutional backers.

And there are more.

While the proposed amounts are not large, it is a rare but growing sign of the times that the firms must resort to such fund-raising events as they grapple with a dearth of liquidity events.

“It’s not very common, but it is becoming more common in this environment,” said Kevin Delbridge, a managing director at Boston fund-of-funds HarbourVest Partners llc, an investor in both firms. “In the last three months, we’ve seen five or six firms that are doing it.”

The addendum funds are expected to be raised from the same limited partners that supported the venture funds, though both Accel and NEA declined to specify which are being augmented.

Investors, however, want to feel secure that their new money is not being squandered to save a sinking business. “They need to be very, very careful where they put that money, and they should ensure that these are going to generate very good returns to investors,” Delbridge said.

Venture firms have had to deal with many difficult issues lately, not the least of which is performing triage. This means shutting down nonperforming portfolio companies and propping up more promising ones with additional capital.

Lackluster IPO market and fewer acquisitions owing to depressed stock values have denied venture firms the cash flow to recycle capital back into the fund for follow-on investments.

Moreover, venture firms generally do not make cross investments, where they use money from one fund to invest in an earlier fund’s portfolio. NEA does it only selectively and only with the approval of its investment committee. “We promised our limited partners that we’re not going to use one fund to bail out another,” said Stewart Alsop, general partner at NEA.

Accel generally doesn’t make cross investments either. Yet it doesn’t want to miss out on the opportunities to invest in good companies. “This isn’t about companies in dire need of capital,” said Alan Austin, Accel COO.

One New York private placement agent who declined to be identified, agrees: “You could have fundamentally good operating companies that are not able to access capital markets at a given time. Capital markets for VC funds right now are difficult for taking companies public.”

Alsop said an addendum fund is “only one of several options” the firm is weighing. “We are prepared to fund our companies with the existing funds as well,” he said.

Part of the problem can be traced to the truncated investment cycles over the past several years. With an IPO market that was heating up, many venture firms had anticipated companies going public in relatively little time. Thus, they sometimes didn’t budget enough for follow-on investments. Traditionally, a fund reserves about 50% or 60% of the capital for that purpose.

Before 1998, the average investment period to build a portfolio was three to four years. That period was shortened to one year in 1999 and 2000 before the bubble burst a year ago.

“We think that a one-year investment cycle is inappropriate,” Delbridge said. “It focuses too much on the portfolio in one cycle of the market. It also adds too many companies to a portfolio and the general partners are then stretched trying to work with their companies.”

The abridged cycle can work if investors can get in and out of an investment quickly enough. “It’s still not a great way of doing business, but it can work,” Delbridge said.

The flip side, however, could get unpleasant. “I hate to use the term, but these venture funds have constipation,” he added. “The stuff is going on one end, but not going out the other.”

Delbridge warns that the firms run the risk of losses on the supplemental funds as well, if the IPO markets don’t open quickly. “They’ve got to ensure they’re not throwing good money after bad,” he said.

But some investors believe the IPO market will stay closed for several quarters, which inevitably will result in venture firms pulling the plug on some companies.

For the supplemental funds, the firms hope to raise enough money for their portfolio companies to have between 12 to 18 month’s worth of cash.

So far, reactions from the investor community appear mixed, Delbridge said. “I think investors are not necessarily ecstatic, but I think if they like the general partners, they will back them,” he said. “It’s mixed, bordering on negative for those that haven’t performed.”

Accel has $3 billion under management. It raised $1.6 last year, with 25% invested to date. In 1999, it raised $600 million, and in 1998 it raised $275 million.

NEA, now managing $4.8 billion in assets, raised $2.3 billion for its 10th fund last year. This followed $880 million in 1999, $560 million in 1998 and $310 million in 1996.

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