Yet another credit crunch casualty: venture capital firms, and potentially, their portfolio companies. The Wall Street Journal reports that VCs are seeing an increasing number of rebuffs, some borne of necessity, when they hit up their limited partners for dough (reader note: investors in private equity and venture capital funds do not remit the full amount committed at the closing of the fund, so these “capital calls” were contemplated in the partnership agreements).
The article mentions in passing that VCs suffered from missed capital calls in the dot-bomb era. Private equity funds did as well. I recall a partner in a PE fund of fund saying that nearly half the money committed to PE then was from wealthy individuals, many of them from Wall Street, and a large percentage of them was missing capital calls).
This then begs the question raised in an earlier post, on endowments selling their PE holdings, even though they are taking very big discounts to get out. Some readers suggested that they wanted to escape capital calls, particularly since the money was almost certain to be going to replace maturing debt (many of the recent deals had been done with a large component of short-term funding, and a fair bit is maturing now, just as interest rates for junk credits are super high). Given the high cost of exit, and the fact (as the article describes), some high profile investors, such as Calpers, are adopting the “just say no” approach to capital calls, why aren’t endowments doing the same? Are the endowments insufficiently tough-minded?
Indeed the Financial Times tells us the reverse side of this story, namely, that investors are ganging up on PE firms and telling them to forget about the idea of getting more money from them. This too parallels the VC experience in the dot-com bust, when funds were (effectively) told to shrink because the money crowd did not want to be putting more money into tech during a recession/post Y2K downturn.
From the Financial Times:
Some of the world’s biggest buy-out groups are coming under pressure from cash-strapped investors to reduce their commitments after Permira’s unprecedented offer to let its backers off the hook for €1.5bn.
Those most at risk are funds with poor records…
….private equity bosses have long boasted they have money locked up for a decade.
But now investors are turning the screw to discuss renegotiating the terms of these previously rock solid commitments…
But today many investors in private equity funds are considering something akin to a buyer’s strike. While most pension funds – the bulk of the money for private equity – say they have no trouble meeting calls for money, endowments and foundations have been hit by losses and some may no longer be able to afford to write cheques they promised.
From the Wall Street Journal:
From pension funds to rich individuals to once-deep-pocketed financial institutions now in desperate shape, this year’s plunging markets have made it much harder for some investors to come up with the money they promised to invest in venture-capital funds…The funds typically collect on investor commitments through periodic “capital calls.”
In October, Washington Mutual Inc. skipped a $700,000 capital call from a fund called Financial Technology Ventures Fund III…In late September, WaMu missed a $30,000 capital call to another fund, Arch Venture Fund V….
Defaults can cause venture capitalists to run out of money to keep start-ups alive.
Some venture capitalists are concerned that the fallout from defaults will be more prolonged this time because there are so few deep pockets around. During the tech bust, Storm Ventures, a venture-capital firm in Menlo Park, Calif., was able to sell the stakes of individual investors who couldn’t meet their commitments to institutions, which still had plenty of cash on hand.
Now, though, “there is distress” spread widely among all types of investors, says Sanjay Subhedar, a Storm managing director…
“In all likelihood, a number of institutional investors will not honor capital calls,” predicts Cynthia Steer, a consultant at Rogerscasey. While doing so could break legal agreements, there are few precedents for venture-capital and private-equity funds suing their investors, since they need to maintain long-term relationships with the investment community.