The Cash Panic Sweeping The VC Industry
Well, for one thing, because they're not boneheads. This economy has the potential to become the worst economy since the Great Depression (it isn't yet, thankfully). VCs see this and understand that:
- Profitable exits are going to be a lot rarer in the next couple of years, and
- Potential investments--including current portfolio companies--are going to get a lot cheaper in the next few years (and, therefore, returns on future investments are going to get a lot higher than today's) .
That logic alone explains why money has gotten so tight so fast. But VC sources say there's also another important dynamic going on: The folks who supply the money that VCs invest--Limited Partners such as pension funds and endowments--are now strapped for cash because the values of their own portfolios have plummeted (and so many of the investments are illiquid). Some are reportedly beginning to default on or defer commitments. In VC-land, in other words, as elsewhere, the oxygen is being sucked out of the room.
Here are some notes from SAI conversations with two VC sources this morning:
There are now unbelievable difficulties in the LP world. Many of the best names are having liquidity problems. They are having trouble meeting capital calls from Private Equity and VC firms and need to sell stocks to get cash. Much of their stock portfolios are tied up in hedge funds with lockups, however, so they can't liquidate those positions.
Some Limited Partners are starting to default on their commitments to VC firms [this is scuttlebutt, not firsthand knowledge; the sources' firms have not seen defaults]. In some cases this can mean they lose their investment to date, but since the LPs think the the VC funds are going to be losers anyway it does not matter. Some second-tier VC funds are reportedly looking at the fine print to see if they can sue the LPs who don't follow through on their commitments.
[In case you don't know how VC funding works: When a VC "raises" a $100 million fund, what the firm really has done is gotten commitments from LPs that they will deliver $100 million over the life of the fund. The firm then issues "capital calls" over the next few years and gradually draws the money down. It is these calls that some LPs are reportedly starting to default on.]
The most agressive LPs have been hurt the most. For example, a rumor is circulating that Columbia's endowment fund is illiquid [can't raise the cash it needs to fund current commitments]. Harvard is trying to sell 1/3 of its private equity portfolio at a steep discount in a secondary offering. You would only do this today if you are really in deep doo doo.* [Private Equity Online is reporting this--see below]
The market price for LP positions in VC funds on average is 75 cents on the dollar. Limited partnership positions in PE funds are selling for 50-60 cents on the dollar. This suggests that $50-$100 billion in value has gone in the past few months from PE funds alone.
The major university endowments are reportedly down 25-30% on a mark-to-market basis [sounds extreme, but certainly possible]. Big universities are heavily in commodities, PE, VC hedge funds, and very little in bonds. They are getting killed across the board
Pension funds are a little bit less aggressive but they also may be more exposed soon.
We have only spoken to a couple of VCs about this, and we assume many firms are not affected. We have heard the endowment scuttlebutt before, though (Princeton was a name that came up a few weeks ago), and it makes sense: University endowments need to fund massive cash spending every year, but they also don't like to compromise annual returns by keeping much of the portfolio in cash. So now that the value of ALL assets has plummeted and so many endowment investments are subject to lock-ups, it certainly sounds plausible that the funds are having trouble raising necessary cash.
Any VCs or LPs care to weigh in? We'd love to hear from you. All sources obviously kept confidential. hblodget@alleyinsider.com.
See Also: Harvard, Yale, et al, Down 25%-30%?
A secondary market source described the university endowment, which had $36.9 billion in assets as of 30 June, as a highly sophisticated limited partner making a proactive decision to seek liquidity and rebalance its portfolio based on cash flow models.
Although the volume of supply in the secondary market has risen of late, secondary investors expect it to surge further in the first half of 2009 as more LPs make a similar move to access needed liquidity...
Harvard’s secondary sale will drive down prices in the secondaries market because it will take $1.5 billion of demand out of the market at a time when supply is not rising, the investor added.
For the 2009 fiscal year, Harvard has a target private equity allocation of 13 percent up from 11 percent for the 2008 fiscal year. The endowment currently has roughly $4.5 billion in private equity commitments, according to sister data web site Private Equity Connect.
Apple buys Yahoo.
Leverage all of yhoo's cloud stuff (mail, flickr, etc) and create super iTunes that makes use of yahoo search. Start turning iTunes into a social network tool with the pic sharing, etc.
And then apple buys Facebook and now you have a really powerful internet company that makes sense!
Better culture fit for yahoo & apple & Facebook, plus you cement apple as a dominant internet company for the next 50 years! Think of all the free apple advertising alone!
MSFT is garbage, if they buy yhoo it will end up getting turned off in 2 years because msft is the opposite of cool & clearly has no idea how to run a web company.
Have a great weekend all.
Why do people buy Macs, iPods, iPhones and use iTunes? It's to have fun on the web and to share their personal lives. iTunes is dangerously close to a social networking site already so why not take the plunge?
They could sell search to msft and then outsource apple related sites to goog if they wanted to stay away from that game.
Seems like a neat way to create a real web company that might create some jobs as opposed to the SS Titanic that msft/yhoo would be equivalent to.
We need some postive M&A deals that make sense to get out of this funk!
If this blog post portends the future then it should get more readers than any other in our industry today. The rumor about Harvard's endowment trying to sell at a deep discount.
Couple Questions:
1. Are you absolutely sure that some venture firms have had lps default on commitments? As you know, the penalty for these defaults are severe.
2. Are your sources from any of the firms in even the top two quartiles of funds? In other words, are these peripheral funds or do we think of them as established venture capital firms?
Aaron
Thanks. Sources are from top-tier firms. To stress, however: The sources are not seeing defaults themselves. They are hearing about them elsewhere in the industry.
Common sense suggests that if LPs starting to cut back, they would start with weakest firms first, so this makes sense.
Also, source stresses that LP's not just cutting back because cash-strapped. They are rationalizing that they've put 20% down and the fund will lose more than that so better to cut losses now than throw good money after bad.
Of course we don't get excited until the funds are wired.
Unless someone confirms, your report of defaults sounds more like the opening shot for a renegotiation of fund sizes/capital commits.
And if it is confirmed, whoa nelly.
1) As their public holdings are getting decimated their private equity begin to represent significantly more of their portfolio than their own allocations targets permit.
2) Once one or two LPs have reduced their commitments to a given fund the other LPs allocations to that fund become more significant. No LP wants to be the majority/only backer in a given fund so they start reducing their commitments accordingly. It can turn into a bit of a death spiral.
To Aaron's point about severe penalties: can you really see a GP taking their LP to court or even to task? SRSLY? LULZ.
Nemo.
Also they confirmed delays but were not aware of defaults.
Don't plan on Green tech either. If Obama has any money left he will give it to the national labs, universities, and defense contractors that get cut on the defense side and call it "green investments." They will do the same work with the same people and call it a different name. It would be stupid to lay off existing workers because of government cuts and hire new ones at new companies with the money when you real objective is to put money into the economy.
Silicon Valley needs to wake up and take a lesson from Detroit and do things that make real money for real products again or we will be making Edsels here and they will call it "Rust Best West." The boom is over, hard work now.
we haven't heard or seen any indication of LP defaults
i think its more likely we'll see interests hitting the secondary markets for the reason mentioned already in this thread. but other than the hardvard sales, which we heard about, we haven't heard of anything else.
clearly LPs are now overallocated in PE and VC and they'll have to adjust.
like always, the weaker firms will be the hardest hit with this. nobody's likely to be selling or defaulting on their sequoia partnership interests
fred
The next cycle of VC will be smaller VC funds <$50 exits with total cash invested of less than $3M-$4M per company.
The VC's that recently raised $900 million funds will be at a disadvantage during the next cycle - assuming their capital calls are met. Those huge funds should turn into hybrids where they acquire many $50M companies and roll them up for IPO's. The only problem here is that more than 80% of Vc's have never held an operational role in a company, only read about in during a semester at Harvard
Times are changing!
I'm baffled by the surprise; every downturn, Silicon Valley tries to argue that it's insulated from the public markets, and every downturn, it is wrong.
If I were an LP, I might offer the following...in exchange for letting me out of my capital commitment, I would pay the balance of the management fees immediately. I would be taking a bath, but I'd get liquidity.
strange for liquidity-strapped endowments to sell companies cheap to fund PE commitments so PE firms can buy those same companies...
but Schwarzman says it's a great time to be a PE investor so it must be true
http://www.economist.com/people/displaystory.cfm?story_id=12551987
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