Beating the big freeze

In the absence of exit opportunities, venture firms are increasingly turning to the secondaries market to generate liquidity. Christopher Witkowsky reports

As the global economy continues to struggle, and credit markets remain frozen, venture firms are turning to the secondaries niche to find some much-needed liquidity.

“For the right situation, it's a great option to have out there,” says Renee LaBran, a partner at California-based venture firm Rustic Canyon (Rustic).

Rustic has cut two deals in the venture secondaries market recently in the absence of other exit opportunities.

It helped facilitate a secondary sale, in which limited partner the Chandler Trust sold its entire interest in the firm's $550 million debut fund to venture secondaries specialist Saints Capital. The Chandler Trust was the sole investor in the fund, which was raised in 1999. Portfolio companies in the fund include Astea International, a customer relationship management software company; kitchen products retailer; and copyright licenser iCopyright.

Rustic also sold 20 percent of its total stakes in eight companies from its $180 million second fund to Saints.

The venture firm's participation in a US Small Business Administration programme that provided debt had ended, and the firm needed capital, according to LaBran. Both sales were used to generate capital in an environment in which exits are virtually impossible, according to Tom Unterman, managing partner of Rustic.

LeBran claimed the firm received “full market value” for the sale of its interests in the second fund and was happy with the pricing. He added that the deal was ahead of the crowd and that discounts will become steeper as more assets enter the venture secondaries market. “I suspect there's a lot more assets on the market now, and that the discounts will be significant,” LaBran says.

The firm had held the companies in its debut fund for almost 10 years and the Chandler Trust was expecting to cash out of the fund this year, Unterman says. In that sense, the situation was somewhat unique, LaBran says, and Rustic doesn't expect to complete any more secondary sales any time soon.

“I think the 1999 funds were a little bit unusual. We had a fair amount of dry powder and we were able to support some of those companies,” LaBran says. “Now we're in another dry spell for liquidity. We had companies that were still quite in their infancy in 2001. A lot of those portfolio companies are at a point where they're real companies and are profitable and now there's no liquidity again.”

Sources in the venture secondaries market have seen activity heat up in the past few months as the exit environment for investments has frozen. Funds raised a decade ago like Rustic's debut fund have called all committed capital from limited partners, yet portfolio companies need more money in the struggling economy.

According to the National Venture Capital Association (NVCA), there were six venture-backed IPOs in 2008 in the US, compared to 86 in the whole of 2007 (see table on p. 43).

“The crisis in the financial markets has further exacerbated an already troubling situation in that most venture-backed companies are postponing or abandoning an IPO exit for the foreseeable future,” Mark Heesen, president of the NVCA, said in a statement.

“These companies that are ready to exit are very strong, with positive earnings as well as innovative technologies and business models, so they will remain in the venture capital portfolio until conditions improve,”Heesen added.

Many venture firms invested heavily and quickly at the turn of the century just before the dotcom bubble burst. Flush with cash, those venture firms now have 10-year-old portfolios that are “stacked” with companies.

IPO NO-SHOWVenture capital's liquidity crisis in part stems from the near absence of stock market listings, as shown by the table below

Year Total Number Average IPO Offer
M&A of IPOs ($m)
2002 319 22 95.9
2003 284 29 69.8
2004 346 94 121
2005 351 57 78.7
2006 370 57 89.8
2007 360 86 120
2008 260 6 784