NEW YORK - The plunge in venture cap fund returns might be bad news for most investors, but it has helped business at Venture Capital Fund of America Inc., which buys secondary partnerships in venture capital funds.
"We're seeing about 30% more deals," said Dayton Carr, founder and chairman. The New York-based firm, which has $250 million in assets under management, is invested in 140 different partnerships. Founded in 1983, VCFA pioneered the secondary private equity business, buying assets of limited partners that needed liquidity quickly.
Mr. Carr said he thinks many companies in the venture capitalists' portfolios remain very overpriced, emphasizing he and his colleagues conduct a great deal of due diligence and are being especially careful before buying a partnership. "There is tremendous risk," he said.
Even though it might mean passing on some deals, VCFA is sticking with its strategy; it has worked well over the years, yielding an average annual return of 30%. "We require a 60% to 70% discount on the partnerships we invest in, and generally pay 40 cents on the dollar. We also avoid most funds specializing in early stage companies, Internet and telecom. In addition, we won't buy a fund if at least 50% of the capital hasn't been called," said Mr. Carr.
The venture cap sector is particularly risky now because so many companies launched during the boom years might not survive - which is why VCFA focuses on the later-stage funds. It also is investing more in leveraged buyout partnerships. Later this month,the firm will launch a fund, targeted at $250 million, to buy out investors in other LBO funds.
"It is easier to judge later-stage venture or LBOs," Mr. Carr observed. "With early stage venture, there is enormous product risk. Will it (the product) sell? Will it last? Will the company be able to produce it? With the more mature companies, the product is already a known commodity, so it's less risky."
VCFA buys mainly from corporations, insurance companies, wealthy individuals and pension funds, if they need to sell a partnership. Some investors sell because the investment already has made most of its money and they need the liquidity so they can move into new investments, Mr. Carr said. In addition, many of the previously wealthy individuals who lost a lot of money in technology during the market downturn need to cash out of some of their limited partnerships. Other sellers, particularly big banks, roll over portfolios to get access to other financial transactions and relationships, he explained.
Mr. Carr got into the business in the late '60s, when Thomas Watson, then president of IBM Corp., gave him $10 million to invest in a venture fund. When Mr. Watson was appointed U.S. ambassador to the Soviet Union, it was necessary to sell what was left of the fund, and Mr. Carr realized there was an untapped market in creating liquidity for wealthy investors. At first, he invested only in partnerships of wealthy individuals, but gradually expanded to include those of insurance companies, corporations and banks.
Many partnerships have gone on the block in this down market, and the appetite for secondaries has grown. Mr. Carr estimated $4 billion will be raised for secondary partnerships in 2002, compared with the $1.4 billion raised in 2001.
Catharine Burkett, director of private investments at the $1 billion endowment of the University of Richmond, Va., said she is very cautious about where she invests these days, but is open to opportunities in secondary partnerships. "They are more proven than first-time investments, since the money is already there, and it's easier to see what the assets are, compared to investing in a blind pool," she said.
She invested $2 million in Mr. Carr's fund when an opening occurred last year, explaining she had known about the fund and had asked to become a limited partner. She would have invested more, but the fund was closing and $2 million was all it could take at that time, she recalled, adding she really liked the strategy. "They don't buy at big auctions where the highest bidder wins. They are known buyers with their own network for these deals and can negotiate better prices."
Other investors in the funds include the $2.4 billion Financial Institutions Retirement Fund, White Plains, N.Y.; the $2.3 billion pension fund of McDermott International Investments, Nassau; and the $330 million endowment of Haverford College, Haverford, Pa.