Is Venture Into Buyouts a Recipe for Disaster? –

When the venture industry was booming in the 1990s, buyout firms hopped on the bandwagon. Perhaps the most memorable example of this was TH Lee’s Internet Fund, which has yet to exit most of its investments from the era, like, and Unfortunately, many buyout firms that got in on the action did so a little too late and lost big. They all quickly went back to what they knew, buying and selling more mature companies.

Today, there are at least a half dozen examples of the opposite happening. Venture firms Boston Venture, VentureNet Capital Group and Watermill Ventures have all done buyout deals this year.

One buyout investor says it’s a simple matter of venture firms still having too much money to put to work in early-stage deals. “I would say there is a lot of overhang in the venture industry, and it won’t be able to absorb all that capital, so a VC has two options – return capital or shift gears and invest in bigger, later-stage deals,” he says.

Among the early-stage VCs that have done recent buyouts are Austin Ventures and Battery Ventures. Both firms say that there is nothing unusual about them venturing into the buyout space, but there certainly isn’t anything common about it either.

Austin has done 35 buyouts throughout its lifetime, a small number compared to 382 venture deals, according to data compiled by Thomson Venture Economics. Similarly, Battery has done 8 buyouts, compared to 323 venture deals.

Nevertheless, Neeraj Agrawal, a senior associate with Battery, says: “We have been looking at technology buyout deals more. If you look back to the early 90s, we did later-stage deals, but then shifted into early stage. We always look for the best risk return, and we are returning to a more balanced investing strategy.”

Battery Is Charged

In particular, Battery focuses on technology and a recent buyout of Made2Manage fits that focus, Agrawal says. Made2Manage, based in Indianapolis, is an enterprise software provider for small and midsize manufacturers and distributors that have revenue of between $5 million and $250 million. Battery closed the $30 million deal using funds from Battery Ventures VI. Prior to the deal, Made2Manage had been public.

Agrawal was mum on the details of this transaction, other than to say that a large commercial bank provided the debt. A Battery spokesperson says the firm’s LPs expect buyout investments from it and did not object to the Made2Manage deal.

Look for Battery to do more buyouts. “We think there will be good technology in the buyout segment,” Agrawal says. “In technology, there is a hot market and there is a more mature market. Broadly speaking, lots of the hot companies are starting to mature and there are opportunities for us.”

He adds that regardless of how great the buyout sector may become Battery will stay more focused on earlier stage growth investments.

LPs Don’t Mind

The same is expected from Austin Ventures. Clark Jernigan, a principal with Austin, says its buyout of Staktek made sense but doesn’t mean Austin is changing its focus. “Buyouts are within our charter,” Jernigan says. “Our strategy is to provide a return for LPs and we are not changing that. But we will predominately remain early stage.”

Austin bought Staktek, a memory solutions provider for OEMs, for $127.5 million with $40 million in senior debt provided by Comerica Bank and Guaranty Bank. “Staktek is right in our backyard and we liked the management team,” Jernigan says. “We weren’t sure what was going to happen with the deal or what kind of liquidity they were looking for, but this is the way it happened.”

Austin doesn’t anticipate any big changes for Staktek and hopes to continue growing the company and then look for an eventual exit via acquisition or IPO.

While two recent buyout deals done by venture firms does not constitute a trend, it could become more common because of an abundance of mature companies with relatively low valuations. That is coupled with the fact that a huge number of companies got funded from 1999 through 2001, which has paved the way for all the late-stage opportunities.

Indeed, the percentage of early-stage investments as part of the venture pie dropped about 20% between 2001 and 2002, while expansion- and later-stage buying increased by 20% over the same period, according to Thomson VE.

“In general, venture firms are recognizing that there is not a dramatic increase in valuation during early stages of a company,” says one investor who asked not to be named. “Accordingly they are looking for investments in companies that have hit key milestones. There’s no point in getting involved in a company when the company is going to have a flat round, so many are waiting until the companies get to a later stage.”

No Worries

Despite the situation, buyout pros don’t seem too worried. Douglas Newhouse, a managing partner at Sterling Investment Partners, says that venture firms are definitely moving into the buyout space, but that it doesn’t bother him. In fact, “We’re doing a deal with a VC fund now,” he says. “The firm has spent 30% of its fund that was raised in 1999. Several of their deals are wiped out. So now they are looking at buyouts.”

Newhouse adds that venture players won’t hurt traditional buyout firms. “Buyout deals are different than venture deals, and the venture community comes from a different place in terms of deals,” he says. “They are used to having one or two deals that are big hits and eight that aren’t. It doesn’t work that way with buyouts.”

Jay Jester, a senior vice president with Audax Group, also expressed little concern over VCs. “It’s not something I’m losing a lot of sleep over,” he says. “The last thing I want is more competition, but as long as these guys have a good head on their shoulders they are welcome to join the fray.”

Danielle Fugazy is Editor of Buyouts, a VCJ sister publication. This story originally appeared in Buyouts.