Venture Capital - downturn

Venture Capitalists Have Flashbacks as Institutions Dump Stakes

Universities and pension managers are dumping their holdings in venture-capital funds, depressing values by as much as 50 percent as the financial crisis extends to private companies.

Investors have venture-capital stakes valued at more than $2 billion up for sale, double the $800 million this time last year, said Hans Swildens, principal at Industry Ventures LLC, a San Francisco-based firm that buys venture stakes.

The glut may lead to a chilling in the venture-capital industry that rivals the slowdown between 2000 and 2003, when investments fell 81 percent, Swildens said. A decline in demand for startup investments may push their value lower and slow the development of new products.

``2009 will feel like 2001,'' Swildens said in an interview. The current environment feels like the third quarter of 2000, he said. ``Everyone knew the market had changed.''

Stakes in venture-capital funds are changing hands for as much as 50 percent less than their original value, said Bondurant French, chief executive officer of Chicago-based Adams Street Partners LLC, which advises clients on private-equity investments. Investors are willing to shoulder a loss because they have few other ways to liquidate their holdings, he said.

Most pension funds have policies capping their exposure to alternative investments, making the situation worse, said Stuart Frankel, a partner at Grotech Ventures in Vienna, Virginia. As stock markets plummet, those investors are being forced to rebalance their portfolios and sell VC holdings even if they haven't lost money, he said.

`Out of Whack'

``The size of their other portfolios, in stocks and hedge funds, has gone down so much they're out of whack,'' Frankel said.

Venture-capital firms gather commitments from universities and pension funds in pools as large as $2.5 billion, which are invested over 10 years. The money isn't collected until the firms identify which startups to invest in.

Venture funds compensate investors when startups have initial public offerings or are bought. If investors want out earlier, they have to turn to brokers such as Cogent Partners or Nyppex Holdings LLC that sell stakes in a secondary market.

The value of private-equity and venture-fund stakes handled by Cogent will rise by two-thirds this year, Colin McGrady, a managing director at the Dallas-based company, said in an interview.

`Hard Look'

``When fourth-quarter numbers come out for the stock market, a lot of institutions will take a hard look at what's the right time to make a shift,'' McGrady said.

Nyppex, which runs an exchange for interests in VC funds, has seen the dollar value of stakes sold double this year, said Larry Allen, the firm's managing member. The value of stakes in top-performing private-equity funds, including venture funds, fell an average of 12 percent in the first nine months of the year, according to Nyppex. The value of stakes in below-average funds declined 37 percent.

Little information is available on who is selling venture stakes. The University of Virginia's investment management company may explore the secondary market for sales of a small amount of its interests in older private funds, CEO Chris Brightman said in an e-mail. The company, which oversaw about $4 billion in assets as of last month, hasn't made sales yet.

Harvard University's endowment was in preliminary discussions about reducing its private-equity holdings, a person familiar with the situation said last week.

Capital Calls

The lack of IPOs and acquisitions mean only the best venture firms will generate positive returns, said Mike Speiser, a managing director at Sutter Hill Ventures in Palo Alto, California. The top 10 percent of firms make almost all the money, he said.

This year, six venture-backed companies have had initial public offerings, the fewest since 1977, according to the National Venture Capital Association, an industry group in Arlington, Virginia.

The worst scenario may be for institutions to refuse to meet commitments they've already made to venture-capital funds. The penalty for refusing so-called capital calls can include forfeiting half of the money already invested, Adams Street Partners' French said.

That strategy is still rare. In a study of more than 50 firms by the National Venture Capital Association this month, none admitted investors had refused to supply promised money.

``We haven't seen direct evidence of that problem,'' said Peter Barris, managing general partner of New Enterprise Associates in Chevy Chase, Maryland. ``I've had limited partners call to find out if other limited partners are having trouble. There's a little bit of, `Where there's smoke, there's fire.'''