Friday, March 26, 2004
Interview: Colin Wallace, Publex Ventures
Colin Wallace is Managing Director of Publex Ventures LLC, a new public/private equities merger fund which is attempting to put a new twist on reaching liquidity. I spoke with Colin about Publex and what they are trying to do.
BK: What's the idea behind Publex?
CW: In today's economic environment, the principals believe that many micro and small cap companies are willing to sell their stock and enter into mergers and acquisitions and creative financing arrangements at greatly reduced valuations in order to obtain the strategic and tactical investments required to exponentially increase the market, attractiveness and value of their stock. The Principals believe that this provides the Fund with a great opportunity to invest in companies at greatly reduced valuations while maintaining significant leverage on assets and milestones to reduce risk.
Despite the downturn in the market, the venture capital industry continues to grow - in 2002, 108 funds raised $6.9 billion in capital commitments. Comparing figures from 2001, capital is being raised faster than new funds are being created, raising the average fund size in 1998 to $134.3 million (from $91 million in 1997). In addition, over 50% of investments in venture capital still come from institutional public and private pension funds. Unfortunately for entrepreneurs, capital requirements for early-stage companies are not increasing nearly as quickly as the preferred investment size for the venture capitalists that finance them. The Principals believe that because of the risk typically associated with smaller early stage investments and the heightened risk aversion after the terrorist attacks of September 11, most venture capitalists typically pass over smaller (under $1 million) investments. The Principals believe that a market of smaller investments will continue to grow, but will also continue to be ignored by large funds providing an opportunity for the Fund to fill the void, negotiate highly favorable investment terms and generate the multiples of early stage investment with lower risk and faster liquidity.
The most popular exit strategy for venture capital investments has traditionally been an initial public offering. The primary driver of this strategy is that on average, public companies sell at higher price multiples than private ones, according to research conducted by Mergerstat and Done Deals. The table below summarizes this trend:
Average Acquisition Multiples
Multiple Privately Held Publicly Traded
Price/Earnings 12.9 21.3
Price/Cash Flow 11.0 15.8
Price/Revenue 1.0 1.1
Price/BV 5.3 2.7
Price/Assets 2.0 1.2
In spite of the apparent premium afforded to public companies, only 23 venture-backed companies went public in 2002. The companies that went public did so on a large scale: the average offering size was $85.6 million. However, the IPO slowdown was a major factor in the modest 9.6% returns generated by venture capital funds. The Principals believe that this trend, combined with industry consolidation and the demand for better returns, will drive strategic acquisition to become an equally dominant strategy for exiting a venture capital investment. The Principals believe that mergers and acquisitions are generally executed more quickly, are more attractive to entrepreneurs because of SEC restrictions on selling founders' stock to the public, and are not as susceptible to volatility of IPO's. Additionally, the Fund may invest in companies that will employ other liquidity strategies such as reverse mergers and SB-2 filings.
BK: What's the major differences you see between what you will be doing and other venture funds?
CW: In a slogan "LIQUIDITY BY DESIGN" The Principals believe that there is significant value to be unlocked in this environment and an opportunity to actually realize this value with faster and more controllable liquidity. To achieve this, the Fund's strategy is to invest in viable public companies (cash-flow breakeven or better with predictable revenue) and capable management teams, but require either additional funding or synergistic acquisitions to enable these companies to achieve the financial growth required to become highly attractive to investors and acquirors. In parallel with the Fund's public company investments, the Fund will seek to find and invest in promising early stage companies that are synergistic to the public companies the Fund will invest in, or have a substantial opportunity for rapid liquidity and that have protectable, validated solutions but have not been able to raise requisite cash through traditional venture sources. The Fund will invest in such combinations with the intention of facilitating the merger or acquisition by the public company of the synergistic early-stage company. As well, the Fund will from time to time utilize secured debt instruments that provide a bridge to exit and liquidity.
The Principals believe that investing in this manner will enable immediate liquidity along with the superior returns associated with a successful early-stage investment. The Principals believe the value proposition to all involved includes:
. To Early-Stage Companies - They receive funding, coaching, networking, and strategic consulting, obtain a stronger and more realistic venue in which to launch and/or market their solution (the public company), become significant shareholders in the public entity and position themselves for fast and successful liquidity.
. To Public Companies - They receive funding and/or coaching, access to a compelling new technology/product (from early-stage companies) that will provide the company with a unique value proposition and/or competitive market advantage, they get revitalized revenue and profit potential and commensurate interest from analysts/investors with immediate stock leverage.
. To the Fund - The Fund gets a stronger, lower-risk portfolio with faster, more controllable exits and returns that are still commensurate with early stage investments. For example, taking a $0.30 public stock to $6.00 provides a 20X return.
The Fund intends to make investments that are smaller than the mainstream venture and investment banking firms prefer, but will pave the way for participation of larger entities.
The Principals intend to utilize their specialized experience in early stage, high-growth companies and markets to formulate strategies for leveraging and merging target companies. The Principals are individuals experienced in successfully operating and growing small companies into successful enterprises. The Principals believe that they will be able to provide entrepreneurs and senior managers with the capital, resources, experience, and connections needed to move their companies into the next stage of growth.
The Fund's approach to venture investing is to take a proactive role in helping small companies merge with later stage companies and public companies. While it is customary for venture capitalists to be involved in strategic decision-making, our approach can also be very tactical in nature, as we will assist, where appropriate and beneficial to the company, in the areas of operations, sales, marketing, investor relations, public relations and business development. This element of our approach defines the difference between a source of capital and a strategic financial relationship. It is this guiding principle that embodies the investment philosophy of the Principals.
The Fund may also, when appropriate, utilize secured debt instruments, warrant coverage, imbedded hedge, look back provisions, redemption options and stock restriction and leak out agreements to provide greater security that management of portfolio companies that the Fund invests in will meet their milestones, especially regarding meeting deadlines for providing the Fund liquidity.
The Fund's strategy is to look for opportunities in which experienced managers & entrepreneurs are on the cusp of a breakthrough in a high-growth industry. An ineffective technology/operating/financial/or management strategy, or insufficient capital for expansion may be a barrier that we can help break down Merging complimentary technologies that bolsters the effectiveness of both companies is of major interest to the Principals. The companies the Principals will work with should be receptive to thinking openly about operational changes and mid-course corrections that are often the difference between being a small business and being a growth business.
BK: How did you, Bill Collins, and Mark Chasan come up with the idea?
CW: The Partners have all been professional "angel investors", investing in seed round companies looking to have our investments supplemented by senior up round Venture Investors who would inturn take the companies through IPO and achieve a high multiple liquidity event. That model no longer exists. It does not work for the "angel investor", the Venture Capital Funds, nor the companies they invest in. The IPO market is all but closed, the subsequent Venture Investors are investing in follow financing to their currenlty illiquid investments, or they are investing in such a narrow criteria as to displace most all early stage companies, they in fact have become almost middle market investors, competing with bankers.
Our approach was very simple, we needed to make our own liquidity events happen and make them happen when we are engineering the original investment. As frustrated "angel investors", we grew tired of the 7-9 year maturity cycle that the early stage investor is currently facing. We were forced to alter the playing field or find a new investment startegy. We did both. The current model is created from a very large collective "PAIN", that is being experienced by "angel investors", Venture Funds and the compnaies attempting to raise capital. The system is broken, the old Angel Investor/Venture Capital/IPO model no longer works, build a new model. Very basic entreprenuerial thinking.
BK: Where are you in raising your $40M fund?
CW: We are raising approximately 70% of the fund from Institutional Investors currently frustrated by the broken Venture Capital model, and from the Venture Capital companies themselves who seek liquidity from their illiquid portfolio companies, and are working with our model and seeking to invest in a "fund of fund" relationship. 30% will be found from the High Net Worth "angel Investors", who like us are frustrated at the current model.
BK: Have you made any investments yet?
CW: The partners have made five (5) investments in public compnaies that we are working with to find strategic candidate companies. In addition we are in due diligence with thriteen (13) companies that meet the private/public critera for investment. We are hopeful that the fund will be profitable before we actually close the finance round.
BK: Thanks! More information »