'Hey – everything's great – valuations are right down and there has never been a better time to invest!'
That’s the spin swathes of venture capitalists are putting on the market’s plunge. You’ll hear it everywhere. But you won’t hear it from Larry Lepard, managing partner of Geocapital Partners in New Jersey.
Late last year, Geocapital responded to the harsh investment climate by pulling its latest fund. “We had commitments doing well on it,” says Lepard. “We had a couple of hundred million and a target of between four and five hundred million.”
But the outlook was poor. “We looked at the money raised and the investment climate,” says Lepard. “And we saw the amount of money we had left in our old funds. We don’t know where the bottom of the cycle is. It’s not a good time to be doing deals.”
Yet many VCs think it is a good time to be doing deals. They say the market correction has brought down crazy valuations and that they can now get more for their money. Lepard says they are not telling the full story. “It is getting cheaper to invest,” he says. “But if something worth $100 has a price tag of $1000 and is then discounted to $800, then the discount still does not make it a god deal.”
Many of these relentlessly positive VCs may be sweating under the weight of the huge funds that they have raised and are now under pressure to invest. “A lot of money has not been invested,” says Lepard. Marc Saint-John of CVC Europe echoes him: “Over the last two years, the amount of capital raised has gone up from $10bn to $180bn worldwide,” he says. “You can just imagine – supply and demand.”
This discrepancy can only lead to one thing. “There will be carnage,” says Lepard. “A lot of companies are spinning their results at the moment.” The spinmeisters are however coming under more and more pressure. An industry observer, John Cochrane of the University of Chicago, recently published a paper lambasting the practice of VCs not counting unsuccessful investments when calculating returns.
He found that investments in about 8000 US companies between 1991 and June 2000 yielded average returns of just five per cent when failures were included in the calculations. Without them, returns averaged 25 per cent.
But Lepard says the figures can’t mask the reality for much longer. “It’s just the tip of the iceberg,” he says. “I don’t wish it on anybody, but we are going to see some terrible results in the next year or two. And there is nothing anyone can do to prevent it.”
Lepard believes that many of the investors now staring into the abyss fundamentally misjudged the business. “So many institutions convinced themselves it was a one-way ticket,” he says. “But you can lose it all or make 10 times your money – it’s that kind of volatility.
“The VC game gets itself into all kinds of mischief because it so long term,” Lepard continues. “You don’t know how well something has done until five or ten years after you have given it the money.” The volatility touches everyone – Geocapital has made its share of hi-tech investments that now have cloudy futures. “We made our bet and will live with it,” he says.
Inevitably, the vultures are circling. “Secondary volume is way up,” says Lepard. “But the spreads are pretty damn large. It is never clear who is getting the better deal. In our Geocapital 2 fund, we sold our interest in a company for twice what we paid. The guy who bought it ended up getting seven times what he paid.”
However, Lepard says Geocapital has no plans to invest wholesale in the portfolios of struggling competitors. “Buying entire portfolios is not really our business,” he says.
Meanwhile, it’s time to face the facts. Last year's rich pickings come once in a blue moon. They won't return tomorrow, no matter what the spin doctors would have you think. “The belief that the market will recover in six months or a year is unbelievably misguided and naïve,” he says. “How are you going to correct the excesses of five years in six months? And the excesses were so large…”
Lepard is setting his sights on a longer time horizon. “There will be a great opportunity in four or five years,” he says. “And guess what – we’ll jump on it.”