Big Deal: exit options

This week’s Big Deal analysis is about an exit, or rather a lack of one. In fact, the absence of lots of exits.

Cornelius Mueller, head of research at the European Private Equity & Venture Capital Association (EVCA), in a presentation to the trade body’s corporate venturing roundtable members this week said there were now more than 21,000 portfolio companies in the 3,700 funds it monitors from 19 national associations.

And this number keeps on growing. While Mueller said there were 5,063 (including 146 corporate-backed) divestments in the five-year period between 2007 and 2011, there were about 27,000 investments, of which corporate venturing made up just less than 1,000, according to the EVCA charts.

In 2011 alone, more than 4,800 companies received investments in Europe with an average of €3m per company, so more than 60% of the investments were attributed to venture capital, the EVCA said in its annual report.

More than 2,000 companies were divested in 2011, split broadly equally between VC and buyout/growth. The same pattern of over-investment compared to divestment (whether by volume or value) has been repeated at least since 2000, although the number of new investments per year has declined since year-2000’s record of 10,000. 

So what does it mean? Given that most portfolio companies are held at cost unless there is a reason for a valuation change, such as a new round at a different price, having a large number of to-all-intent living dead zombies could be skewing the performance figures.

These figures are already pretty low at 6.1% for the decade to end-September, which is less than US stock market indices over most ranges in the past decade, according to data provider Cambridge Associates. The living dead with little chance of selling at a profit – of which there must be a fair few given that write-offs count for about a fifth of all exits – could be a greater drag on returns.

There is also an impact on how long an investment needs to be held. The holding period for non-corporate venture-backed companies is about 6.1 years on average, falling to nearly 4.5 years if a corporate is an investor at the time of a portfolio company’s divestment, Mueller said.

Again, count in the living dead and these figures would presumably shoot out even longer.

In Global Corporate Venturing’s expectations for the year ahead, published in our January issue, this issue of longer exits and dealing with portfolios treading water were identified as an issue. Corporations currently building up a programme need to put in place a strategy for managing the issue.

Fortunately for corporate venturing, the factor could be less important if there is a strategic rationale to work with a portfolio company. But this could be held hostage to a change in strategy or just a lack of dynamism in the company that is stagnating rather than growing.

The rest of the EVCA’s roundtable was more optimistic. There were about double the number of attendees than in previous years, which partly reflects the growth in the industry but also likely down to the dynamism brought by its chairman, Markus Thill, co-head at Robert Bosch Venture Capital (RBVC).

Thill said its goal was to provide strategic help to its parent through introductions and feedback on entrepreneurial trends beyond just its actual investments. But he said it also needed the investment performance to beat its cost of capital, which is about 8% per year.

To tackle the cost of capital challenge and deal with governance issues on living dead portfolio companies, a number of corporate venturing units said they had or were moving to an evergreen structure.

Dominique Megret, head of Swisscom Ventures, at the EVCA roundtable said the annual returns pressure it had faced had been reduced when it moved to a so-called evergreen fund structure, which meant it reinvested the proceeds of its exits in new deals. This leads to a growing programme if the team is successful or its eventual collapse if the team fails to deliver.

Pieter Wolters, the relatively new head of DSM Ventures, added that it, too, was moving to an evergreen model as part of an evolution in its programme.