Big investors turn away from VCs as the financial crisis takes its toll.
By Michael V. Copeland
LAST UPDATED: OCTOBER 3, 2008: 2:00 PM ET
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SAN FRANCISCO (Fortune) -- If you are a venture capitalist looking for a new limited partner" you are going to find it tough in this market says Harold Bradley manages $2.1 billion for the Kansas City, Mo.-based Ewing Marion Kauffman Foundation.
Venture capital, as every VC is happy to tell you, operates on seven-to-ten-year cycles. Firms don't, for the most part, use debt to fund their companies. So in theory they should be shielded from the financial mess that has laid waste to some of the largest financial institutions in the world. But no one is getting out of this unscathed, and certainly not the gang that occupies Sand Hill Road in Silicon Valley.
Venture capital operates via commitments. A limited partner pledges a certain amount to a fund, and as the VC firm needs it, it makes capital calls to get that money to fund its portfolio companies. If you don't pony up when asked, you typically lose all your prior investment and are frozen out going forward. After the dotcom crash, capital calls came from VC firms and some limited partners simply said no - whether it was because they were wiped out in the Internet implosion, or they didn't want to throw good money after bad.
It could be worse this time around. "My expectation is that it will start first in some private equity funds, that there will be a substantial miss on a capital call, and we'll see it next in venture capital," says Paul Kedrosky, an investor and academic focused on the future of risk capital and writer of the business blog Infectious Greed. "No one is going to stiff Kleiner Perkins, but the second or third-tier guys will get stiffed all day long."
The conversation among limited partners in VC funds these days is all about who's got casht, and who doesn't. What you want is cash now - not a one, three or five year wait to cash in.
Says Warren Weiss, a partner with Palo Alto-Calif.-based VC firm Foundation Capital: "If you are a private company with a big cash burn, you are in for some pretty tough times. We're going to see more fire sales than mergers. You'll see a lot of companies in the $200-$400 million range that can't go public now, get acquired. The weak will get weeded out."
With hedge funds, buyout shops, even venture debt funds mostly on the sidelines, money is about to get really tight. The pressure will fall on VCs to decide which of their portfolio companies live and which die. Weiss believes liquidity is the key to navigating the next 12 to 18 months. "If you are a startup or a limited partner, it's no cash, no company," Weiss says.
Bryan LeBlanc, CFO of Portland, Ore.-based startup Jive Software, agrees. "If you are not cash-flow positive you are in a tough spot right now," says LeBlanc, whose company develops collaboration software for the workplace.
FIRST PUBLISHED: OCTOBER 3, 2008: 1:05 AM ET