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The Venture market: Is there trouble brewing at the exit?

exit signPeople are wondering if the mega buyout party is coming to a close.

The private equity and debt market have been been in bed, for a little while, and it was looking to be a cozy relationship - like that of two people who sorely need each other. Large buyout funds were using the arbitrage opportunity between debt and equity, and easy access to cash, to fund large deals.

Now, one of the partners is not so rich, and not so free wheeling, anymore. With the sub-prime snafu in the debt market, LBOs are finding themselves up against the wall as far as access to easy debt capital.

The doomsday scenario is already starting to play out a bit, according to WSJ. Two anticipated IPOs in the hedge fund business, Man Group and MF Global fared less than, well, stellar. Both fell short of their targets in initial raise.

Then there was Blackstone and their spectacular IPO (highest ever for a Fund). That IPO is also finding itself in the doldrums, now.

So what does all this mean for the venture market? Used to be that start-ups that fared well, would go one of two ways. They would have an IPO on Nasdaq, or they would get bought out by larger companies, which in turn have been snapped up by large hedge funds in recent years.

First came Sarbanes-Oxley, and taking a company public became like a political race. You couldn’t go to the party unless you had really rich parents. Worth about $500 million and up. Some companies dodged the bullet by staging an IPO on AIM, the London stock market, where it costs 60% less to IPO. Nasdaq certainly became a less attractive option for all other than the well heeled and the brazen.

Then came the LBOs and a wave of, we hope, rational exuberance. Suddenly venture firms could see the “Exit” sign in the distance. The money started flowing into start-ups again.

Now there are rumblings of discontent in the private equity arena. If the deal flow slows down, it could affect the venture market, which is down the financial food chain.

There is also the dynamics of the venture funds raising capital. The PE funds are the pick of the litter there. Large pension funds such as Calpers, which invest in PE and VC funds, prefer to place larger amounts of money since, as they see it, it is about the same amount of work for them (in due diligence etc.) to invest $5 million in a fund, as it is to invest $100 million. So late stage funds have an easier time raising funds, than early stage funds.

In principle, one would assume, that if the PE funds were to fall out of favor, smaller venture funds would swoop in and pick up the extra cash. But I don’t think that is going to be the case. If there is a perception that the pipe is choking up at the exit, it will affect all sizes of funds, in their ability to raise and deploy capital.

So far, the numbers show an upbeat picture in venture land. The large companies like Google and Cisco which have been snapping up start-ups in the last few years (this year, Google surpassed Cisco in venture backed acquisitions - 5 versus 4 as of early June), aren’t that sensitive to the capital markets, as long as they keep growing and hitting their numbers. This year, the total volume of mergers and acquisitions in the first half of 2007, was above a $1 trillion, an overall record according to Dealogic.

Notwithstanding the shenanigans in the hedge fund IPO business, the market for Venture backed IPOs continues to hum. Venture backed IPOs raised $2.73 billion for 22 companies that debuted in the second quarter of 2007, an up higher already, than all of 2006.

It is not clear if there is trouble brewing further down the road, but so far, venture traffic continues to move along smoothly.

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July 30th, 2007 Posted by Toni DasGupta | Venture Capital, Opinion | no comments