Low Values Lead VCs to Eye PIPEs –

MENLO PARK, Calif.? Traditionally thought of as the reserve of profiteers, (PIPE) private investments in public entities deals appear to be attracting increased attention among venture capitalists. Established VCs, whose funds have in large part remained on the sidelines as firms worked with portfolio companies, are beginning to see sizable upside in trying to restore fallen- angel public companies to their previous glory.

One of the most recent examples is the deal struck between Menlo Park-based e-crm company KANA Inc. and Technology Crossover Ventures, which agreed at the end of November to purchase between $38 million and $45 million of convertible preferred KANA stock in a PIPE deal. The deal is subject to shareholder approval, which should come sometime in mid-January.

TCV, which has done three PIPE deals over the last year or so, looks at PIPEs as being akin to late-stage venture deals, said Jay Hoag, a partner at the firm. ?From our point of view, these are expansion-stage deals for companies that happen to be public,? he noted, adding that like a typical late-stage deal TCV plans on the life-cycle of its PIPE investments from initial investment to exit to be three to five years.

Indeed part of the attraction of PIPEs today for VCs lies in the glut of public companies that debuted on the public markets prematurely and have now fallen on bad times due to the massive decline of the public markets. Even though many of these companies likely deserve their current fate, there are some that are quality enterprises that have built their businesses out quite substantially and now can be had at a fraction of their cost of creation, said Dan Burstein, a managing partner at . Millennium Technology Ventures, which has looked at about 100 potential PIPEs and done one deal and currently is interested in two others, Burstein added.

The other, and primary, reason to do PIPEs today is that they have the potential to generate fairly sizable returns for VCs. ?We want the PIPEs we do to have return characteristics that are like a VC deal, which means we probably want at least five-times our money back,? said Peter Barris, managing general partner at New Enterprise Associates. NEA, which did a PIPE for a health-care company in November, pursues PIPEs opportunistically.

At a time when traditional venture deals are currently hampered by a lack of visibility in terms of when the public market exit window will open, for promising, but down on their luck, public companies PIPEs offer VCs a way to put money to work with a fairly clear path to liquidity. ?Even good PIPEs have conversion provisions in three, six or nine months, as well as warrants and other bells and whistles, so this allows quick gains or, even, early exits, if the deal is not working,? Burstein noted. ?There are not going to be a lot of new technology IPOs in the near future, but with a PIPE you can schedule your exit to a certain extent and monetize that value.?

VCs exploring PIPEs as an option are not simply looking to be passive investors who make a quick buck by hoping the public markets once again heat up for a particular company. In order for a PIPE to be successful, firms must be committed to working with the company in question. ?We only do a PIPE when it looks like a venture deal,? said NEA?s Barris. This means NEA expects to take a board seat and work closely with a company?s management team, he added. Likewise, when TCV does a PIPE it brings a traditional venture approach to the company in which it has invested. To that end, Hoag took a board seat with KANA.

VCs who have done PIPEs recently say their commitment to working with the public companies they invest in is what separates them from the type of investor responsible for the notorious toxic PIPE. ?I don?t worry about the negative impression created by death spiral pipes, which, I think are predicated by passive investors, who short a company?s stock to make a quick profit,? said TCV?s Hoag.

Moreover, the environment for PIPEs now has changed fundamentally, Millennium?s Burstein said. ?What is new is that you have hundreds of companies with large market caps, big followings among institutional investors and analysts, and which had charmed the marketplace,? he said. ?Now that has all gone away, but these are still a much different quality of company and investors than the sort of people and businesses doing PIPEs previously.?