Venture-Capital Revenue Continued Decline in 2002
By ANN GRIMES
Staff Reporter of THE WALL STREET JOURNAL
January 2, 2003
Venture capitalists spent much of their time last year trying to stay on good terms with their investors, regain their equilibrium, and get the industry back to where it can again produce the big returns it is known for.
Returns to investors, valuations, deal flow and available dollars all continued to decline in 2002. The amount of money raised for venture capital fell to levels unseen since 1995.
"It has been a milestone year for the venture-capital industry," says Gil Forer, head of the Venture Capital Advisory Group at Ernst & Young. He cites "a number of challenges," including a possible decline in the number of venture-capital firms, a difficult fund-raising environment, and the impact of federal corporate-governance legislation on VC-backed companies. In addition, continued stock-market volatility last year meant fewer opportunities to get cash out of funded companies through initial public offerings or mergers and acquisitions.
VCs often "paid back" investors by reducing the size of their funds and cutting management fees. Recently, in what could be a sign of more concessions to its investors, Benchmark Capital of Menlo Park, Calif., allowed individuals in one investor group to opt out of a capital call, or a demand for additional cash, thus limiting their investment in its $1 billion Benchmark IV Fund without the usual penalties.
NEW YEAR'S RESOLUTIONS
What Mark Heesen, President of the Venture Capital Association, says venture capitalists will be thinking about this year:
• Improving relationships with investors
• Working more effectively with portfolio companies to make them understand that profit, revenue and having a customer base, etc., count if they want to get funding.
• Figuring out how to get back to long-term investing in exciting young companies, to produce the returns and the innovation needed to keep the industry moving.
It isn't likely to get better soon. Mark Heesen, president of National Venture Capital Association, a trade group, predicts this year will be very much like 2002. Unless the economic picture looks better in six months, he sees "no dramatic increase or decrease in funding of entrepreneurial companies, but an uptick in seed and first-round financing."
Many venture capitalists had expected the pain to be over by now. But it took them longer than anticipated to figure out what to do about the huge number of companies created by the 1999-2000 funding frenzy, many of which are struggling. Last year most of the available capital -- 80% -- went to shore up existing portfolio companies through follow-on financing, rather than to new start-ups. And the painful triage may not be over yet.
"I do not think we have yet cut to the bone," says Jonathan Silver, a general partner with Core Capital in Washington, D.C. "We've cut through most of the fat and into the muscle, but not to the bone yet."
John Gabbert, vice president of world-wide research at VentureOne, an industry-tracking firm, agrees. "We're still looking at 11,000 private companies world-wide," he says, adding that roughly 10% of those are profitable and may choose to remain private. Of the remainder, the majority "have scaled back their operations to a level that, while sustainable, will not yield the desired returns to their investors."
As a result, valuations of private companies declined last year. VentureOne reported the median "premoney valuation" in the third quarter -- the estimated value of a company before it is funded -- fell to $10 million from $11 million in the second quarter, figures on a par with 1996 levels.
Colin Blaydon, a professor at the Tuck School of Business at Dartmouth, says valuations for good deals "have remained pretty high." But the low- and medium-quality deals "have fallen through the floor or are not getting done."
Only a handful of technology companies made initial public offerings of stock, and a much-anticipated public debut of Seagate Technology failed to provide the much-desired bounce during the fourth quarter. Overall, venture-backed mergers and acquisitions also were off considerably from where they have been for the past few years.
Only $1.2 billion was raised for venture funds in the third quarter, the most-recent data available, far below the peak of $24.3 billion raised in the fourth quarter of 2000. Capital raised for all of 2002 is expected to come in at about $22 billion, less than in that single three-month period, according to the National Venture Capital Association.
There were a few exceptions, the Carlyle Group, based in Washington, D.C., raised a $600 million technology-oriented venture fund. MPM Capital, based in South San Francisco, Calif., closed a $900 million biotechnology fund, its third. The firm expects to invest the funds over a period of four to five years.
Mr. Heesen, NCVA president, says he expects the average size of funds will fall back to their prebubble levels, "but having said that, I see little fund raising going on, particularly in early 2003." If a few firms are successful, he says, "you may see other funds, which originally were waiting to go out in 2004, go out in 2003 to beat the rush."
Asked whether venture firms will continue to reduce management fees and cut the size of funds, Mr. Heesen said in an e-mail:
"A lot may depend on whether we start to see an opening in the IPO market (which many VCs don't yet see in 2003) or a better acquisitions market. If both continue in the doldrums, we may see more reductions in the latter part of the year, as firms gear up to fund-raise in '04 and '05."
But Mr. Blaydon at the Tuck School notes that funds invested in economic downturns historically have produced the highest returns. "The big question," he adds, "is whether that is likely to be the phenomenon going forward."
Write to Ann Grimes at ann.grimes@wsj.com
Updated January 2, 2003 |
