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Venture Capital in Crisis

with 6 comments

We have the good fortune to have Brian Caulfield on the board at PutPlace.com. At a board meeting yesterday Brian gave a chilling analysis of the state of VC across the globe. Afterwards he sent me a bunch of links supporting his analysis.

In short whatever problems you have raising money for your startup, the VCs are seeing those problems double.

VC’s raise money from what are called Limited Partners (LPs). When a VC announces the closure of a round what they have actually got is a commitment from the LPs to provide funds to support investments over the 10 year lifetime of a typical VC fund.

As the VC makes investments they make cash calls on the LPs to support those investments (Enterprise Ireland’s 175m is still sitting in a government account somewhere, even though most of it has been committed) so throughout the lifetime of a fund the LPs continue to feed cash into the fund.

Most LPs are in fact pension funds and those funds are experiencing the same smack upside the head that the rest of the financial system is still reeling from.  So they have asset pools that have halved in value and as a result they have no liquidity to meet the cash calls of the VCs they have invested in.

This is resulting in a VC double whammy (and by extension companies looking for VC money). The first problem is that LPs are writing off their existing investments in VCs and trying to withdraw from any future commitments to the fund. Legal issues abound here and we can potentially expect to see some LPs  sued for this behaviour.

The second problem is that LPs who are honouring their commitments are approaching VCs en mass and saying “don’t make any investments as we won’t be able to meet your cash calls for the next while”.

The net effect of both these issues is the same, VC money is drying up faster than Sahara rain drops.

So, raise as much as you can, at whatever price you can, plan to have at least 12 months cash in the bank and get to break even ASAP.

http://www.alleyinsider.com/2008/11/the-cash-panic-sweeping-the-vc-industry

http://venturebeat.com/2008/11/07/cash-panic-sweeping-vc-industry-the-capital-calls-problem/

http://www.pehub.com/22812/lps-are-on-the-ropes/

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Written by Joe

November 12, 2008 at 10:17 pm

Posted in Uncategorized

6 Responses

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  1. Great post Joe – but it only affects less than 5% of Irish entrepreneurs 🙂

    Some funds will be ok [those with decent track records] – but i would anticipate a lot of the Irish VCs [who have financial institutions as LPs] will be under the kosh. Perhaps we will see a secondary market appear in Ireland @ LPs/VCs [would be one way to clean up the potential mess].

    See http://tinyurl.com/6dfcy4 for good commentary on secondary markets.

    Btw, did you see that BDO are raising monies for VC funds – http://tinyurl.com/5eqwnf – surely it would be more wiser to have a “First Round”/”SoftTechVC” fund based in Ireland.

    Fergus Burns

    November 13, 2008 at 10:44 am

  2. Yes, and the 5% number is a problem in itself (BTW: How did you come about that calcuation).

    The AIB Seed Capital Fund is trying to address that market in a meaningful way, but suffers a little from still acting like a VC despite investing seed round amounts (I think their cap is 250k). The problem with being VC like is you end up paying VC legal fees. So suddenly 5% of your capital is up in smoke to a legal firm before you’ve even cashed the cheque.

    I’ve said it before, EI needs to be more aggresive in this space and take a more hands on approach to allocating capital to seed funds and controlling how that money is invested. There dump of cash into the Irish VC market has so far had zero impact on the amount of funding that is flowing into early stage companies.

    Joe

    November 13, 2008 at 10:53 am

  3. Hi Joe

    Working on some analysis on funding [and its scary] – the IVCA figures are misleading – but it looks like 5% of Irish ventures are VC backed – rest are angel/BES/none…

    You only have to look at the recent successful companies/exits – not a lot of them had Irish VC monies

    talk soon
    fergus

    Fergus Burns

    November 13, 2008 at 3:56 pm

  4. Great post Joe,

    What really gets me is the EI money sitting in a government account, fully committed to private third party Irish VC’s (ok, one Public one – but they like buying hotels now), who now won’t be using this money ‘cos the LP’s won’t follow. I know it’s venture funds, and as such (and as Fergus rightly points out) applicable to only a small group of potential suitors, but if they changed the game to a philanthropic, “risk it for a biscuit” approach, who knows how many Polldaddy’s, Auctomatic’s etc might gestate…

    Just my tuppence…

    Shane Mc Allister

    November 14, 2008 at 11:53 pm

  5. […] Joe Drumgoole covers venture capital in crisis […]

  6. […] Sometimes the best part of these kinds of seminars are the discussions with other attendees that happen afterwards. This is where the silverish lining emerged. Some people believed while the VCs are becoming more cautious they will still do deals albiet less deals and reduce the reduce the average investment. That might put them into the investment range of many of the Web/Software companies who are looking for €200-400k investments. This class of companies have been in a bit of an investment vaccum recently as commented by Fergus Burns in Joe Drumgoole’s post about VCs in crisis. […]


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