Wednesday, October 01, 2008

Venture Round: And now the bad news

It’s popular to suggest that the venture capital world is somewhat insulated by the turbulence on the public markets, but let’s get real. That’s not the case.

Last week, we offered a potential "bright side" scenario. The likelihood that boutique investment banks will finally get the sunlight and the attention to grow large enough to support a small, revenue-poor industry like life sciences.

But such a development, while positive, will take a while. Until then, we’re looking at a number of potential negative impacts, many of which we’ll explore in our upcoming magazines.

Fundraising: Three words. Forget about it. If you’re not a top-quartile, blue-chip fund you’re going to have a terrible time trying to raise a new fund.

And those firms that have raised new funds aren’t off the hook. One venture firm with AIG as an limited partner still hasn’t heard whether or not the insurance giant's commitment will be honored.

Even those firms with limited partners not being bailed out by the government could face some problems down the road as they begin to call down portions of the fund. Some LPs may simply say, no, sorry we don’t have the cash—or even the appetite—any longer.

This might lead to fund reductions, similar to what we saw after the technology boom busted. But in this case, GPs won’t be giving capital back for lack of investment opportunities. They’d be doing it because of lack of support from LPs. (In fact, one professorial type told PE Hub that VCs should be nice and give some of their money back. We're not really buying that one.)

Early-stage investing: Big funds probably won’t be doing it. Why should they when they can have their pick of later-stage companies that will be hungry for capital. As for the angels, well, they’ll obviously be a little risk averse given the current situation. But they too will have the option of investing in “later” early-stage companies, the kind of companies that VCs backed until now. We’re not sure if angels can provide enough of the capital those more established start-ups need, but they’ll be given the opportunity to invest.

Mid-stage investing: So you have a product about to start clinical trials, which puts it on track for commercialization in five or six years, maybe, after some serious infusion of cash? Good luck with that.

Late-stage investing: This could be a blood bath. VCs with capital will be obligated to find bargains in this market. At this point, no one is willing to admit this, but we’re expecting some serious hammering on existing investors. To be sure, VCs can’t be too cutthroat since they too have companies that will require outside capital, but if they can get a late-stage company at early-stage prices then they have to do it. And look for more and more PIPEs. (BTW, we ass-U-ME-d incorrectly last week. The Angiotech deal involving Ares and New Leaf Ventures is not dead yet. We're told something may indeed happen.)

Exits: It’s been said that we’ve been through IPO droughts before, and that’s true. But this isn’t just a drought. Somebody blew up the pipeline and poisoned what's left in the reservoir. As for the corporate buyers, yes, pharma and medical device companies SHOULD be buying. But will they? And if they do what sort of prices will they be seeking. Just as venture firms have to answer to LPs, corporates have shareholders who demand value when it’s available.

In fact, VentureWire Lifescience released some sobering statistics today. We’re back to 2003.

Health care companies have created $3.01 billion this year through IPOs and M&As, down from $8 billion at this point in 2007, a 62.2% drop. That's the worst nine-month performance in five years. Through September 2003, life sciences companies had produced $1.33 billion in M&A and IPO liquidity.

It’s worth pointing out that health care accounts for most of the liquidity activity since the entire venture industry generated $4.3 billion from sales and IPOs in the first three quarters of this year. PriceWaterhouseCoopers Money Tree report offers a similarly glum outlook.

Readers of START-UP already know our take on the acquisition of privately held biopharma companies. Colleagues Ellen Licking and Chris Morrison supplied an exhaustive study in the current issue.

So yes, we’re not dead yet. (We're keeping with the Monty Python theme.) But keep an eye out for the cart hauling dead folks. Oh that reminds us, we see one more significant development.

The Rise of Secondary Buyers: We already reported on their rise in our July START-UP. But, whether it's portfolio companies or stakes in general partners that LPs no longer want, secondary buyers likely will have an easy time finding bargains. Firms like Saints Capital will prosper.

Are we missing any?

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