PureVC

Congratulations Currenex

I have started a new category of posts that I will call "Liquidity Events" to post on interesting sales, IPOs, or acquisitions. For my first post I wanted to take a moment to congratulate Currenex and its $564 mm acquisition by State Street. This is a company that I invested in back in 1999 as an angel when it was originally called FXtrades. Targeted at the huge foreign exchange market, this was one of the first companies to provide an internet based foreign currency exchange with both buy-side and sell-side members that included multi-nationals and financial institutions. At any rate, this company had a fiery start then during the precipitous tech downturn was on the brink of collapse. After a series of recapitalizations by management and outside financial investors, it managed to survive and recently facilitated a $108 billion day of forex trading on its platform. I was unfortunately washed out significantly in the recapitalizations and at one point was certain the company would shut its doors. Based on the recapitalizations I believe the venture investors have made a killing on this deal. This is a true testament to management to persevere through all this. This is also an excellent illustration of how it pays to "double down" or support companies at favorable valuations on the prospects of a rebound.

Congratulations Currenex!

VC Primer: Due Diligence Binder

I haven't posted in my VC Primer series for a while. So far, we have covered: Fundraising, The Carry, Funds of Funds, The J Curve, and Management Fees. There is a topic that has become increasingly important to me and this is the topic of Due Diligence. I cannot emphasize the importance of understanding this topic from both the perspective of the entrepreneur and the investor. I apologize in advance for the length of this post but I want to make sure my readers get the point.

The reason this topic is important to me is that more and more I am seeing entrepreneurs and start up companies who really don't have the first clue as to how to go about obtaining funding. They have piqued the interest of some investors, but they do not know what the next step is. They may have heard the term "Due Diligence" but they really don't know exactly what it means or how it is conducted. Every venture firm or angel investor will have (should have) his or her own protocol of conducting due diligence. I have seen as formal a process as a due diligence worksheet where the company is scored on various metrics. Or as informal as a group of partners giving a company the thumbs up or thumbs down. With angels, I have seen it as simple as a discussion over a cup of coffee.

If you had $5 to $10 mm to invest in the life of a startup company, how extensive would you want to check up on the company and its managers? There are only a few real life examples that I can think of that stress the importance of what due diligence really means. For example: when you go to hire your babysitter or live-in nanny, what kind of information would you want to find out to make sure they are a fit for your family? Surely this would include references, a biography, a resume, and some research about what this person is all about.

If you were a famous politician, what kind of due diligence would you do on your closest security personnel? I would imagine that it would be pretty stringent. If you are lucky enough to survive the treacherous Goldman Sachs interviews and get an offer for a job, they will basically do an FBI background check on you to make sure that you have not had any run ins with the law and that everything you say with regards to your criminal history is true (Don't ask me how I know this!)

An old school financially-minded venture institution will conduct due diligence on a company that will at the minimum include seeing audited and unaudited financials since inception,  all correspondence to investors, all versions of a business plan and its updates, background checks on key personnel, lease agreements, purchase or sale agreements, and employment contracts. There is a good chance that the firm has a due diligence team or will hire outside professional lawyers and accountants to make sure everything is OK. You have to remember that these firms have LPs and have a fiduciary duty to do what they can to make sure their investments are crisp and clean. They want to make sure there are no hidden liabilites or debts that they are going to become responsible for once they become attached to the company.

In short, if you are going to obtain serious venture financing, be ready to go to the Proctologist. They are going to make sure your financials are srubbed squeaky clean. If they sense there is any misrepresentation, then get ready to start explaining.

What does this mean for you the entrepreneur? Well if you know you are going to the Proctologist, then you better start cleaning out your system and flushing yourself thoroughly. You don't want him to find out that you are full of SHIT!!! In ordinary terms this means keeping your accounting and financials clean, having a good reporting system in place, and most importantly, creating a DUE DILIGENCE BINDER!

You don't understand how happy I am when I am interested in a company and THEY send me a due diligence binder that pretty much has everything I want. This means I don't have to ask. I don't have to wait. I don't have to hear some lame excuses about why they don't have the information I want already accumulated. When I work with an entrepeneur who has already prepared one, I know I am dealing with someone highly sophisticated who has been through the drill before. Perhaps he or she has obtained financing before, has M & A experience, or investment banking experience. Anybody who has this prepared obviously knows that the venture financing drill can take a while and they want to make it as expedient as possible.

So if you are an entrepreneur, here is my advice. A good due diligence binder is a royal pain to make. The easiest thing to do is to find out what you want to include in your due diligence binder and make a template of the sections. Update these templates on a quarterly, semiannual, and annual basis - make it a standard part of your accounting and reporting procedures that you report to your shareholders. Some things to include are an update of your business metrics, financial performance, and budget. When it comes time for you to put out a due diligence binder you will already have in place what you need!

I believe a good entrepreneur will create a due diligence binder on a yearly basis even if he or she is not in the market for financing. Creating a due diligence binder forces an entrepreneur to analyze his company as a whole and see what holes are in it.  If he took a step back and looked at the company as an outsider, what weaknesses would he identify? If he is particularly sophisticated, he may realize that the process of updating and creating this binder and report is really a simulation of the rigorous reporting standards required to be on the public markets. If he is very sophisticated, he may take advantage of key advisors and consultants and send this binder out for free feedback that would serve his company well. By having one of these binders in hand, he will be prepared if there is an unexpected event and his company needs financing. If he is having a great day, a potential suitor for his company may come knocking on the door with interest in buying his company....voila! he has a package for them that they can look over and he won't be disrputed from day to day activities scrambling for all this information and potentially turning away an acquirer.

If you haven't figured it out yet, a due diligence binder is far more than just a binder - it is the hard copy that represents a faithful process of reporting, updating, and analyzing your whole business.

I already have my list of what I like to see included in a due diligence binder. If any of my readers have suggestions, please feel free to comment.

New Proposed SEC Rules for Private Equity

I've been on a blogging tear this past week, posting almost every day. I'm not sure what's gotten into me, maybe its just wanting to get off to a running start this new year...anyways, I found an interesting document courtesy of Dan Primack of the new PE Hub. Debevoise & Plimpton has gone ahead and issued a letter to clients regarding new SEC rules proposed for communications by Hedge Fund and Private Equity Managers. Out of fear of some legal backlash, I won't post the document here, but you can get it at the PE Hub link.

In addition to some increases in the thresholds for accredited investor status ($2.5 million instead of  $1 million), the letter proposes broad anti-fraud rules that are important for the industry:

1. The SEC would be the enforcer of any fraudulent communication. It would not be a private right of action but all disputes would go through the SEC.
2. The adviser does not have to have knowledge of the fraudulent or misleading statement.
3. While these types of rules have previously been limited to Investment Offering documents, this antifraud rule will apply to ALL communications.
4. The antifraud rule is not limited to actions of disclosure but include any fraudulent, deceptive, or manipulative conduct.

Well, well, well...my first reaction is "DUH!" these rules are nothing new - all managers of investment pools should be behaving in this manner already. Exhibiting fraudlent behavior will catch up with you in any business - wealthy individual and institutional investors have the firepower to enforce action through the legal system so if you are doing this, you are playing with fire!

While I commend these rules, the sad truth is that while they may seem to protect investors from evil managers, they will inevitably steer private equity managers toward less disclosure and communication.

Private equity managers are notorious for brevity in their communications and their disclosure of investment practices - these new rules will make it even worse. Why send your LPs detailed letters and statements if they will only expose you to additional liability? Additionally, this will increase legal and risk mitigation costs and it is not out of the realm of possibility for firms to retain counsel to now review all correspondence documents, not just investment offerings.

If anything, these proposed rules make it clear that the SEC does not have a handle on the Private Equity Industry. On the one hand, it wants to promote the growth and activity of investment pools. On the other hand, it wants to regulate them without scaring them away.

Fortress Finalizes IPO Terms

Fortress Investment Group finalized its S-1 filing today with a proposed market capitalization of $7 billion. They are among the first global private equity firms that are listing themselves on the public markets. Other firms have listed single funds on the exchanges as ways to raise permanent sources of capital. Fortress is taking the next step and taking their entire firm public.

I am not going to go through the S-1 in detail - this one speaks for itself - a 9 year old firm with $30 billion under management founded by a handful of guys in their early 40s. Take a look at the revenue from management fees and incentive allocation and you will see a pot of gold.

An unintended consequence of this move to become public is the intense scrutiny the firm is opening themselves up to by being a public company. Their S-1 begs the question: Why go public? If this is such a profitable business for its managers already, what do they have to gain by going public?

The company is listing the following reasons: people, permanence, capital, currency. In essence the firm feels that being public will allow them to provide financial incentives for employees, have permanence as an institution, more easily access capital from the public markets, and have extra public currency for acquisitions.

These are all solid reasons and Fortress is definitely showing they want to be a pioneer of Private Equity and go down in history. It will be interesting to see if other firms follow.

My personal feeling is that private equity can be risky and the public may not be equipped to tolerate this risk. On the other hand, PE firms are becoming so sophisticated that it is difficult to differentiate themselves from the investment arms of most prominent boutique investment banks. If Goldman, Lazard, and other boutiques can go public, it shouldn't be any different for great private equity firms.

Providence Says Bye to 25% Carry

As reported by The Deal, Providence Equity Partners is cutting its carry from 25% to 20% for its upcoming fund, targeted at $12 billion. I haven't posted in my VC Primer series in a while, but I did post previously about The Carry and how some firms such as Bain Capital charge hefty carries of 30%. The 30% carry hasn't been that well received by some LPs who argue that in this day of mega club deals, it doesn't make sense to pay for that extra 5% or 10% for non-proprietary deals. I sense that this move by Providence is an acknowledgment of the competitive marketplace that the buyout world has become.

I have always felt that the carry is the best way to incentivize management to achieve outsized returns. I think the industry standard of 20% or 25% is reasonable. However, if PE managers really want to give back then they should cut back on annual management fees. As megafunds increase in size, these annual dues can mount up.

Don't get me wrong, I am a part of and have significant interests in entities who charge a reasonable management fee. However, these fees should be utilized for operating expenses and to pay managers. It doesn't take $10 mm or $100 mm yearly to run an excellent private equity firm. There are some excellent firms that have very fair management fee plans that use all fees for operating costs and everything in excess gets returned or kept but tallied against the future carry carveout. Perhaps we will see some of these changes as LPs become more "active" investors.

I am glad to see Providence come in line with the industry. Hopefully, LPs will take note and reward those PE firms that are looking out for their LPs best interests.

Feedburner's VC Network & The VC Bloggies

I've gone ahead and joined Feedburner's VC Network after accepting an invitation from Brad Feld, the network moderator. I've read Brad's blog, Feld Thoughts, for quite some time now. One of the best things about his blog is his Term Sheet Series, where he and his crony Jason Mendelson discuss the key terms in a financing term sheet. I highly recommend it.

In signing up, I did notice that there are quite a few VC bloggers. Brad has referred to their "replication like tribbles". I am impressed by the proliferation of the VC blogger. I think I will start referring to us as the "VC Bloggies" because I sense our number will continue to grow. One thing I did notice is that Brad and Jason have started another blog called Ask The VC, that addresses questions from readers. Some of these questions are very similar to ones I have been receiving and have addressed in my VC Primer posts. I think it's a great site and look forward to seeing their responses.

One thing that is clear from the VC network and the proliferation of the VC Bloggies is that every VC comes in different shapes and sizes. If you read these blogs you will see that everybody has a permutation of their venture capital method and strategy. I think it is another great resource for the entrepreneur who is trying to get in the head of a VC. Collectively, these VCs control a lot of investing dollars and knowing what they are thinking will get you ahead of the curve.

Anyways, thanks for taking the time to aggregate us and form this network Brad.

Ryan Beck acquired

Last week Ryan Beck announced that it pulled its IPO after it was acquired by Stifel Financial for about $120 mm in stock, including payouts. I previously posted some thoughts on the Ryan Beck S-1 filing. It seems that this is starting to become a common theme in the marketplace - companies looking for funding either privately or on the public markets and then being acquired in the process. I don't have a lot of details in the acquisition, but it seems like a bargain price for the company which in its S-1 filing recorded $250 mm revenue. From the BankAtlantic CEO as quoted in the South Florida Business Journal:

"It was the Stifel track record that convinced us that a primarily stock-based payment was preferable, providing BankAtlantic the opportunity to maximize the return on our investment in Ryan Beck," Levan said. "While we have no immediate plans to sell any of the Stifel stock that we will be receiving and there are limitations on our sale of the stock, we do anticipate gradually reducing our investment, consistent with market conditions and as the combined companies begin to realize the benefits of the consolidation."

Read - we think we will make more money selling Stifel stock because it has a stable trading history versus if we just sold our public IPO stock.

MyBlogLog Acquired by Yahoo!

As reported today by The Deal (subscription required), Yahoo! announced that is has acquired MyBlogLog. If you don't know about MyBlogLog, it is this clever idea to create communities around blogs. It has changed the landscape of blogging from a one way street to more of a community where you actually can get a feel for who is in your audience and what links they are moving on to from your page. I currently use the free service and haven't had the time to fully investigate all the perks of the paid service, but it is obvious from the different faces that I see on this blog that there is some serious viral marketing at play here. I don't even consider it word of mouth - bloggers visit each others sites and see the little face widgets and decide to try it on their own. A few weeks later and there are thousands of users using the service - simply amazing!

While I personally do not measure that much of what is going on around this blog, I do enjoy seeing different faces appear on the blog. Occasionally, I will click on someone's photo and may glean a bit of information about the person. What I do find useful is the tabulating of which links on this blog are the most popular. This in combination with stats I can take from Typepad's traffic log, tell me that a lot of people who read this blog are interested in Hedge Funds. The last time I checked, every day there are about 50 newcomers who find this blog via a Google search on Hedge Funds. I am quite amazed at the interest in Hedge Funds - are these readers interested because they work  in the industry, are looking to find good managers, or are simply Hedge Fund groupies? I don't have the time to take necessary steps to find out but if you are a reader of this blog, feel free to drop me a line anytime. If you want me to write about something in particular, let me know.

Anyways, the whisper number on this transaction is $10 million. Not bad for a company launched in July 2005. As the article points out, Yahoo! is clearly trying to get ahead of the curve by acquiring companies early, like they did with Flickr. It also highlights the fact that many startups are looking for M & A opportunities as they are searching for their next round of funding. What I might add is that I hear some of the founders are running several companies at once - so this example shows that "Parallel Entrepreneurs" that I previously posted about can achieve success.

Congratulations to Eric and his crew for their nice exit!

SkyBridge Invests in Abdiel Capital

I wanted to take a moment to Congratulate SkyBridge on its newest investment in Abdiel Capital Management. Abdiel is a concentrated value fund run by Colin Moran, a former partner at Chieftain Capital, and former Goldman banker. SkyBridge is going to apply their value add through aggressive fundraising and business-building support. Thus far SkyBridge has been successful in seeding and fundraising for its first two investments - Westport Capital and Brompton Cross. Both have raised significant amounts of capital in less than a year.   

Several weeks ago I mentioned the departure of Andy Klein from SkyBridge. It doesn't appear as if SkyBridge has missed a beat since his departure. Typically when you see a founder leave a company it definitely raises eyebrows. Sometimes the management isn't gelling together, sometimes management can't align well with investors, and other times founders simply move on because they see a greater opportunity. In a rare occasion, a founder will step aside because he feels he is hampering the growth of the business.

In the case of SkyBridge, it appears that Klein has left because he in an entrepreneurial guy and sees great opportunity in Spotzer.

As I mentioned in my last post, it is a great time to be a VC. It is a great time to be an entrepreneur. It is a great time to be a Hedge Fund. As SkyBridge shows, it is also a great time to be a Hedge Fund seeder.