Venture firms are looking for new ways to make money--and elbowing onto
investment bankers' turf.
Not content with double-digit rates of return on their investments, some
venture capitalists are looking for new ways to milk their portfolio
companies=E2=80=94by buying more stock in them when they go public. VCs
traditionally have regarded public offerings as an exit strategy, not an
investment opportunity. But in the crazy world of technology finance, sto=
ck
offered to the public can double or triple on the first day. When an
offering is likely to be a hot one, VCs want to be buying, not selling. A=
t
the time they decide to fund a company, they can negotiate the option to =
buy
newly issued shares at the public offering.
Some underwriters aren't very happy about VCs muscling in on their turf.
Ordinarily, investment bankers control who gets most of a new issue, and
naturally they dish it out to the largest institutional and retail custom=
ers
who throw them the most commission business the rest of the year. Other
folks=E2=80=94including venture capitalists=E2=80=94could pretty much for=
get about getting
any stock at the offering price. "It was the one meaningful financing eve=
nt
that they didn't have access to," says William Brady of Credit Suisse Fir=
st
Boston.
When an underwriter underprices a hot Internet offering, it is, in effect=
,
creating a slush fund for its favored customers. The underwriting client =
may
not object=E2=80=94it may be thrilled to see its stock bounce up the firs=
t day=E2=80=94but
it's still leaving money on the table. The VCs are trying to grab some. T=
he
VC option started to appear in later-stage venture deals about four years
ago. An early pioneer was Technology Crossover Ventures, which frequently
invested in portfolio companies after they went public. "Back then we had=
to
stand in line with everyone else," says partner Jay Hoag. TCV has written
the term into more than 30deals, including Autoweb.com, the on-line car
dealer, in which $3 million worth of initial offering stock was set aside.
Accel Partners began inserting the provision in early-stage rounds for
portfolio companies like Mpath Interactive, which makes software to build
communities (say, of karaoke fans) on Web sites. "We view the public
offering as just one more step in building the company, and by no means a
final one," says Accel managing partner James Breyer.
Downside? Once VCs win the option, it's tricky not to exercise it=E2=80=94=
people
will want to know why the smart money isn't buying stock at the offering,
says Bob C. Kagle of Benchmark Capital. Benchmark has asked for the optio=
n,
sparingly. Underwriters argue that a young company would do better to set
aside shares for a new strategic partner=E2=80=94instead of handing out a=
bonus to
investors who have already made a bundle. But it's hard to say who's bein=
g
greedier in this game.
Tushar J. Mehta
email: [email protected]