September 1, 2011

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Cold Feet

Venture Capitalists Hesitant to Get in the Game

Tom Haraldsen

September 1, 2011

When the nation was celebrating the start of a new century in 2000, there were a matching number of venture capital firms operating within the United States. Together, they were providing more than $100 billion to business enterprises, generally garnering sizeable returns on their investments. They were truly a stimulus package.

But that was then, and this is now. Starting with the recessionary 2007, VCs began dropping off the map—a mere 700 of them were considered up and running at the end of that year. Today, the number is closer to 400—an 80 percent drop from just a decade earlier.

The dollar totals have dropped proportionally. From that $100 billion high, estimates today are that venture capital funding is now in the $18-20 billion range. Certainly the economic turndown has been a large contributor to those declines, but not the only one.

“One of the biggest issues that has affected VCs is their inability to go public as they once did,” says Brad Bertoch, president of the Wayne Brown Institute in Salt Lake City. “It’s become awkward and expensive, and not having an exit strategy has really hurt the VCs. When the crash came, many couldn’t buy anymore, and the venture guys lost the ability to really sell their assets. So they ended up with these investments that just won’t go away.”

No Exit
If you were to take a class in Venture Capital 101 (if one existed), it would probably read like this: An investor or investors put their monies into a portfolio (investing in a startup or fairly new company), realizing that they’ll earn a return on their investments, at some point, through divestiture. That exit strategy might come in the form of selling equity in the funded company in three to seven years, or through stock options it gains after an initial public offering when said company goes public.

This strategy worked very well in the ‘90s, when pension plans needed better rates of return as Baby Boomers were starting to retire. The venture market was flooded with cash due to historic high rates of return.

The VC tide turned as the economy did, and Bertoch says that as it did, so did the mentality.

“It went from a ‘value-added for investors’ way of thinking to nothing more than real estate agents,” he says. “They simply wanted to flip the deals. So many of these guys took over the venture industry without the skill sets to do it. That caused a steady decline, and funds began closing down because the rates of return weren’t there.”

Without exit strategies, many of the firms that remained in the game were stuck with the investments they held, and thus no ability to raise more funds. They were high-centered.

A Funding Desert
Though Utah wasn’t initially as adversely affected as other states, including neighboring Colorado for instance, the Beehive State is not immune.

“Five years ago, Colorado had 22 funds, but only one with money,” Bertoch says. “So they started recruiting here, where we had 16 funds that all had money. So there’s been some erosion starting to show here.”

Bertoch says Utah has a few firms still making decent monies, while four or five are soft, and a few others aren’t investing at all—just managing portfolios. Four years ago, there was about $3.5 billion under management in Utah VCs, with around $750 million to invest. Today, while the dollars under management remain about the same, the investment amount is down to around $200 million.

Five years ago, the Utah Fund of Funds was created by the state. It’s a program designed to provide access to alternative and non-traditional capital to Utah entrepreneurs. The fund does not invest money into a company, but will invest in VCs or private equity funds that “commit to establishing a working relationship…with Utah’s startup and business community,” according to its website. Those funds can be both in-state and out-of-state.

“It started out with all the promise in the world,” Bertoch says. “It was well-designed, run by good people, and it got authorization for an additional $200 million.” Bertoch says the problem is that the Utah Fund of Funds hasn’t been fully monetized yet (it remains at around $50 million). “They’ve made some great inroads the past five years, but we desperately need to get them fully monetized now. I’m anxious to see that happen.”

Heavy Hitters
Entrepreneurs often utilize what Bertoch calls the “5 Fs—founders, family, fools and former friends,” when they look for financing to get a business going. That, of course, can only go on for a short period of time. So even as VCs have been declining in impact over the past few years, another new source has developed—angel investors. These are well-heeled, heavy-hitter investors, and the nation has thousands of them. They provide startup capital for a business, usually in exchange for convertible debt or ownership equity. In Utah, as in other parts of the country, angel investors often form groups or networks.

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