In the US, distributions in kind of venture capital stock to investors are a feature of private equity at the flotation stage. While distributions have not hit the European scene yet, the pundits expect it to happen.
A growing strategy in US venture fund exits is to make a distribution to the limited partner (LP) investors of the shares their fund holds in the company instead of offloading them all on the market when it goes public.
Elizabeth Dater of New York-based Warburg Pincus Asset Management says that limited partners in venture capital funds are often on a cleft stick. They want to achieve the liquidity that going public allows, but at the same time want to maximise their returns from their investments. We have done a number of studies which have shown that selling immediately into the marketplace can work against obtaining superior returns. In our experience selling these companies immediately they go public and are distributed can leave money on the table."
Pointing to the UK she adds: "When a company goes public, the venture comany just sells it and gives the cash to the limited partner. We have seen time and again that there has been a depressing effect on the stock's price."
With around 400 venture partnerships currently being monitored by Warburg in the US, there has been an unprecedented number of distributions in recent years. Her organisation finds it has handled 800 to 1,000 distributions a year for its cli-ents, which are pension funds, oth-er institutions and high-net-worth families involved as LPs in venture situations. "Our clients are invested in multiple LPs and they constantly receive these distributions, which we manage as a portfolio. We have about 20 such clients with $1.2bn in these assets." The return on this portfolio is about 20% on a compound annual basis over the past nine years.
For some clients it is just a matter of orderly liquidation of their positions to maximise returns, for others stocks in these companies will be bought. "We have found that the professional management of this asset class can typically result in superior investment returns over two- to four-year periods, thanks to the selective selling process." Also the requirements of SEC rules 144 and 145 means that in the US additional paperwork is needed to remove restrictions on selling some venture stocks and this is another service for clients as up to 30% of issues can have these impositions.
When these stocks come to the market normally they fall outside the scope of interest of the traditional small cap specialist mangers. This creates an opening for Warburgs. Dater says: "We look at this quite opportunistically, as a chance to look at these companies, which have received venture backing very early on in their public life and to ascertain which have the most long-term potential."
It uses the opportunity to vet these companies early on before flotation as they have access to them in their clients' portfolios. "We engage in proprietary research of these companies, employing our fundamental real research process and applying our stock selection criteria." This provides the chance to identify the future venture-backed successes, such as Hewlett Packard or Microsoft, and to add these to portfolios in due course.
A spin-off has been a 'post venture capital' mutual fund investing in companies that have received venture backing and gone public in the past 10 years, which selects companies both in the US and internationally, selected by this research process. In its first two years it has grown to $140m and provide a return of 30% pa compound. Another development has been the Warburg Pincus/Venture Economics Post Venture Capital Index as a tool to track these companies' performance.
Dater thinks the market in distributions is developing in Europe. "As the venture market matures and the capital markets develop, then the needs of investors will be better able to be accommodated. The market for these new unseasoned companies is fairly illiquid in Europe. That there is a greater comfort level with distributions in the US is probably a function of the greater liquidity available in the capital markets," says Dater. Fennell Betson"