Financial sector turmoil humbles local VC industry

At times of crisis, funds have to cut down the amount they seek to raise, and spend more on their existing clients.

One of the repercussions of an economic crisis is that venture capital funds are forced to scale back fundraising plans. The current crisis is no exception. Talk among Israel's venture capital funds in Herzliya Pituah is about one thing: the funds now raising money will have to reduce the amounts they want to obtain.

Genesis Partners, Giza Venture Capital, Gemini Israel Funds, Challenge Fund - Etgar, and Vertex Venture Capital are all raising capital for follow-on funds.

Conditions are not good, to put it mildly, and the collapse of Lehman Brothers and the near collapse of Merrill Lynch and American Insurance Group (AIG) will unquestionably affect the institutional investors whom Israeli venture capitalists usually approach to raise money.

Some Israeli funds have begun to approach Asian institutional investors as an alternative to US and European investors. Pensions are being privatized or are just becoming formulated in some Asian countries, and the new pension funds will undoubtedly seek investment channels. Israeli venture capital funds could be worthy candidates.

Another fundraising alternative that could increase is internal rounds, a common practice in the US. An internal round is a fancy way of covering the distress of companies that are unable to raise capital from new investors, and turn to their current investors for more money. To be fair, this is already common practice in Israel.

Beyond prettifying an unpleasant reality, internal rounds can result in several problems for companies, even if the money is essential for their survival as going concerns. The valuation of a private company is usually made by a potential new investor, who examines the company and proposes a value for an investment. At a time of multiple internal rounds, it is hard to determine updated valuation of the company, which can affect subsequent merger and acquisition proceedings.

A new study by Dow Jones Ventures found that when public markets are closed, and there are almost no M&A transactions, venture capital funds concentrate on their portfolio companies and are forced to invest more in them. Beyond problems for M&A deals, this creates difficulties for new entrepreneurs seeking initial financing for their ventures, because the internal rounds result in venture capital funds having less capital being available for new investments.

The study found that, on average, exits in US during the first half of 2008 came after seven years. This is a record length of time that is not a good thing for the parties involved. The average amount of capital that a company must raise until its hoped-for exit rose to $22 million from $14.9 million in 2001. As a result, venture capitalists must wait longer for exits by their portfolio companies and get lower returns on investment.

Israeli companies that cannot raise capital from new investors will have to make internal rounds. Venture capital funds, which are in no hurry to give up on their portfolio companies, will undoubtedly inject more capital into them in exchange for streamlining measures - a fancy terms whose significance everyone knows.

Published by Globes [online], Israel business news - www.globes-online.com - on September 17, 2008

© Copyright of Globes Publisher Itonut (1983) Ltd. 2008

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