Clouds Over the VC sky
by Steven Dickman, CEO, CBT Advisors
Last week I attended a one-on-one podium discussion put on by Xconomy featuring two Boston gods of private equity and venture capital, Peter Brooke, founder of TA Associates and Advent International, and Terry McGuire, Managing Partner at Polaris, who is also currently Chairman of the US National Venture Capital Association.
Though generally upbeat in tone, the event did not dispel the clouds that have rolled in over the world of VC. Just as Wall Street bankers are facing salary caps and nagging questions from the government, VCs and private equity heads like McGuire and Brooke are struggling with changes in the ecosystem that hit them in the place it hurts the most – their ability to raise funds.
The discussion did not dwell on the challenges of their own next fund-raisings. Both McGuire and Brooke have proven to be adept at raising capital over many fund generations and through very tough times. “This is my fifth economic downturn,” quipped McGuire.
Indeed, large and established fund groups are having some success raising new funds in 2009. For example, Domain closed on $500 million in August (down from an original target of $700 million announced in January but still a strong and quick raise) and PEHub reported last week that New Enterprise Associates (NEA), one of the world’s oldest and largest PE and VC partnerships, had submitted an SEC filing announcing that it had raised $2.45 billion of its $2.5 billion thirteenth fund with $300 million coming in since its previous closing in April, according to the Wall Street Journal.
But McGuire and Brooke touched ominously on the potential re-allocation of limited partners’ funds away from PE and VC. The mood among LPs lately, Brooke said, has been sullen, even mutinous. Therefore, Brooke said, GPs everywhere are asking themselves, ‘Will limited partners find new types of investment?’ And ‘If the LPs’ VC allocations go lower, where will we find our capital?’
Brooke mentioned the report in Forbes that Harvard has $11 billion in unfunded commitments to VC and PE funds. Brooke linked that figure with the earlier data point that Harvard’s endowment has lost $11 billion of value. “If that faucet is shut off, it will have a real impact.” (Read Forbes’ initial coverage of the crisis in university endowments here.) Detailed numbers follow in Addendum 1 below.
Many VC GPs would agree that too much money was pumped into the system in the 2003-2007 time frame. The tail end of that period was extreme by any estimation – too much capital chasing too few deals.
But driven by forces arising from the wider capital & credit markets, the pendulum seems to be swinging back to the other side. The amount of VC raised in 2009, McGuire said, will be less than the amount raised in 2004. This sets up VCs and entrepreneurs for a “new normal” that, while capital efficient, may prove challenging in the short run.
Longer-term, Brooke and McGuire were optimistic. “There is no question that the industry will continue,” McGuire said. “There is no question any more that the system works.” The basis for good VC investments, McGuire said, is seeing a path to solving real-world problems. The sun will doubtless come out again before long for VC since, as McGuire put it, “There are problems that the world and the economy face that have the makings of great investments.”
Addendum 1: The numbers.
Between 1999 and 2008, the size of Harvard’s endowment increased from $14.4 billion to $36.9 billion. It then fell $11.1 billion to $25.8 billion by June 30 of this year. Stanford, whose endowment is down from $17.2 billion in 2008 to $12.6 billion this year, has $6.1 billion of unfunded commitments and told Forbes earlier this month that it was putting $1 billion of its private equity assets up for sale. The issue, according to this August, 2009, Vanity Fair piece, is that there may not be buyers for these positions at anything close to the sellers’ asking price. The stalemate further increases the pressure on LPs’ liquidity.
Addendum 2: Harvard’s dilemma
Here’s a telling excerpt from the VF piece, written by Nina Munk:
>>A money manager I spoke to described his meeting late last year with Jane Mendillo, who in July 2008 became president and chief executive officer of Harvard Management Company. Knowing that Mendillo was trying to unload assets, he offered to buy back Harvard’s sizable stake in his private fund. As he recalls, the surreal dialogue went something like this:
He: “Hey, look, I’ll buy it back from you. I’ll buy my interest back.”
He: “Here, I think it’s worth—you know, today the [book] value is a dollar, so I’ll pay you 50 cents.”
She: “Then why would I sell it?”
He: “Well, why are you? I don’t know. You’re the one who wants to sell, not me. If you guys want to sell, I’m happy to rip your lungs out. If you are desperate, I’m a buyer.”
She: “Well, we’re not desperate.”<<
Maybe they are now.
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