Next Things First


Constancy of Change (from Jory Caulkins) by charlottegee
November 24, 2008, 11:07 am
Filed under: economy, venture capital | Tags: ,

THERE IS NOTHING CONSTANT BUT CHANGE.

My dad will be very excited that I worked this phrase into some sort of professional usage.

Private equity over the past five years (and perhaps more, excluding a short stint in the 90s) has been synonymous with gargantuan LBO deals. Deals in which excessive liquidity in the system allows for large amounts of leverage, and financially engineering a very attractive return given consistent cash flows. Since the dot-com implosion, these mega-deals have overshadowed the rest of the private equity asset class, especially venture capital and early stage strategic growth equity.

With the recent and inevitable credit crunch came the fall of many of these giant deals. But I do not think private equity is dead … its face is just changing. There is a fundamental difference between the environment necessary for these mega-deals to prosper, and that necessary for value-adding venture and growth investors to prosper.

Buyout shops need leverage in order to financially engineer their profitability. This means they need willing creditors, and ultimately liquidity. Unfortunately, these occur in cycles, and we are on a down cycle.

In contrast, venture investors and growth equity investors rely substantially less (if at all) on leverage for returns. Instead, they target disruptive innovation that can change established business processes and rely on the support of risk-tolerant capital partners to fuel their growth with a combination of equity and specialized value added. However, with many institutional investors so invested in buyout funds, I wonder how long it will take traditional fund investors to make a change in their asset allocation to fuel the next wave of venture capital funds.

This means that if you do believe that “there is nothing constant but change” (as I do after years of hearing it from my father), then you ought to be pretty excited about the opportunity set for venture and growth equity investors, especially relative to other current private equity opportunity sets.

Submitted by Jory Caulkins
Morgan Stanley, Mergers & Acquisitions

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