RESEARCH TRIANGLE PARK — Venture capital funds raised the smallest amount of new money in 2002 since 1991, according to statistics from the National Venture Capital Association and Thomson Venture Economics.
While some VCs collectively raised $6.9 billion dollars, others turned back some $5 billion to investors.
The net total of $1.9 billion raised is the lowest since venture funds raised just over $2 billion in 1991. The report described the trend as an “expected sharp decline” and said VC funds are “rightsizing” to reflect the new, post-bubble world.
How hard have times gotten? In 2000, new funds hit $106 billion. Even as the economy slowed in 2001, nearly $41 billion was poured into new funds.
The news hardly surprised venture followers, given that VCs invested $17 billion in 2002 — less that a fourth than the 2000 total ($76 billion) and well under that of 2001 ($30 billion). But it comes as more salt in the wounds for startups and entrepreneurs looking for money.
“You’ve got to be able to put the money to work and get a reasonable rate of return,” said Jeff Barber, partner in charge of PricewaterhouseCoopers in Raleigh. “You can’t invest it without a rate of return.”
Given that the economy is stalled, initial public offerings are scant, markets are down, and merger and acquisition activity is slow, VCs are finding few exit strategies that will generate the ROI they are need. Valuations of companies also have declined, which in turn impacts on ownership stakes of existing investors.
The overhang hangover
But other pressures are being brought to bear, too, according to the NVCA and Thomson report.
The “inordinately large overhang of previously committed capital that has yet to be invested” is one. At the Money & Markets event last week, one panel estimated that $200 billion is available for investment in private capital markets. As of Sept. 30, 2002, NVCA and Thomson estimated the overhang in VC funds alone at $80 billion.
The report also cited a “lengthening fundraising process, lower private company valuations and a shift in industry sectors and investment opportunities that correspond to emerging national priorities” as other reasons. Emerging opportunities include homeland security, military applications, protecting people from various threats and life sciences also are drawing limited partners’ attention away from traditional IT, telecom, “dot com” and other plays.
Another factor not cited in the report but documented over recent months by the media is a largely behind-the-scenes battle between VC funds and their limited partners over management fees. The VCs bill around 2 percent to handle funds.
“Return on capital, pressure for reduced management fees, and on, and on,” are among the reasons for the lack of new funds and the returns, said William Dunk, head of William Dunk Partners in Chapel Hill.
The “overhang” is a mystery to many of those on the outside looking in.
Especially frustrated are startup companies and entrepreneurs looking for capital know money is out there but can’t get it. Asked if he could understand why entrepreneurs are scratching their heads about the conundrum they face, Barber said. “You do. The entrepreneur sincerely believes he has a good idea. At the same time, the risk profile for the venture capitalist is too high.
“If you are close to product or close to revenues, have a good market opportunity and the potential to turn a $5 million or $10 million into a $100 million company, changes are you can get money.
“If you have a chance to hit a grand slam,” he added, “if you really have a good track record, you can raise money.”
Look for new areas
The VC industry itself also could be headed for a massive change in direction, as the report said. Will more VCs be hiring consultants to do due diligence on the startup promising the “next best thing” in bioterror defense or non-lethal weapons? Perhaps. But there may be other less risky alternatives.
To get back on the growth curve, Dunk said VCs must broaden their business horizons.
“I would look at the VC world as just a subset of the whole ’90s phenomenon. That is, there was a worldwide credit bubble where funds were sloshing around and capital was massively misallocated. Now, that will shake out. Many funds will simply disappear,” he explained.
“One of the big lessons that comes out of this is that VCs, especially regional players, were and are too narrowly focused. The deals to be done now are in Old Economy America where there are a lot of bucks to be made by correct venture investing.
“But the funds in general do tech, bio, and did it much too long when they should have in fact migrated to other things.”
Bucking the fund-raising trend, several Triangle area firms, including Aurora Funds, are raising additional money. Aurora has raised as much as $60 million in a targeted $75 million fund.
Other firms have tried to raise money but haven’t been able to, according to Barber. “They don’t have the track record,” he said. “They don’t have the results to warrant raising a next fund.”
For those who want to raise new money, he said, “It’s back to the basics.” The statistics offer further proof that the “easy money” days are long gone.
Here’s how NVCA and Thomson described the hurdles: “Budgetary constraints, extensive due diligence and the desire to invest in more established firms with strong track records are impacting the way Limited Partners invest their money.”
Also putting a crunch on VCs is the declining amount of buyout, mezzanine and other funds, according to NVCA and Thomson. These funds have declined over the last three years from $86.8 billion to $31.6 billion.
“Everything is down,” said Barber. “Their portfolios are down, and they are being more conservative where they put their money.”
Rick Smith is managing editor of Local Tech Wire.