The Corner | ABC Newspapers

Venture capitalists (VCs) play a major role in the development of new businesses. By deciding which of the hundreds of business proposals that cross their desks each year are worth backing, VCs are an important part of funding companies. They are usually organized in the form of limited partnerships. The general partner solicits funds and manages the investments, receiving 2 to 3 percent of the value of the fund for their expenses and 20 percent or so of the profits for their trouble. That trouble can be considerable. The general partner or partners and their staff must be experts in evaluating the large number of proposals that come their way.

Since many entrepreneurs are inexperienced in business, the VCs must often function as a management advisor; some actually usurp the role of chief executive, especially when a company is in trouble and the VCs? investment?which usually ranges from several hundred thousand to several million dollars?is in jeopardy.

Although VCs have traditionally invested in projects that have already been incorporated and need capital to grow, in the early 1980s some investors began backing entrepreneurs in first setting up their companies. These so-called seed capitalists offered funding in the range of $50,000 to $250,000, whereas most VCs felt that deals that small were not worth the expense of investigating.

The venture capital go-go period of the early 1980s drew new players into the field. Encouraged by liberalization of rules governing fiduciary responsibility, many institutional investors took the plunge. These included public and private pension funds, insurance companies, bank trust departments and university endowments. Banks joined in, as did corporations such as General Electric. Of these, the pension funds turned out to be the most enthusiastic. By the late 1980s roughly one half of all new capital coming into venture funds were from this source.

Most remarkable was the emergence of state governments as venture capitalists. About 20 states set up VC programs in order to promote job creation; some invested directly and others gave tax breaks to state chartered VC funds. While most state funds were small (under $10 million), others have sunk more than $50 million into such investments.

In order for venture capitalists to realize a gain on their investment they must sell their equity interest. Sometimes this is done through private placements, but the more profitable and popular method is to take the company public through an initial public offering (IPO).

A handful of smaller investment banks emerged as the leading IPO underwriters in this period. The ?four horsemen? was the label given to L.F. Rothchild Unterberg Tobin of New York, Alex. Brown & Sons of Baltimore and Hambrecht & Quist and Robertson Colman & Stephens of San Francisco. An important, but more notorious, role was played by D.H. Blair & Co. of New York.

The IPO market declined in 1982 but soared the next year to a remarkable level of 888, in which some $12.6 billion in equity was raised. The IPO frenzy of 1983 brought windfalls to both venture capitalists and entrepreneurs such as Allen Paulson of Gulfstream Aerospace and K. Philip Hwang of TeleVideo Systems, both of whom ended up as two of the wealthiest people in the country.

The following two years saw a sharp fall-off in IPO activity, but the numbers of new issues and the amounts raised remained higher than at any time before 1983. In October 1985 the initial offering of stock in Fireman?s Fund brought in $900 million, far surpassing all earlier IPOs. But the following year the Fireman?s offering was topped by the $1.2 billion IPO of Henley Group, a collection of businesses spun off from Allied-Signal. This, in turn, was surpassed by the $1.6 billion Conrail offering in 1987.

At this point the general new-issues market was beginning to heat up once again. This time the range of industries was much greater: high tech was no longer dominant, and the popular issues included everything from specialty retailers to yogurt. The stock market crash in October 1987 put a temporary damper on IPOs, yet a record $24 billion was raised in IPOs that year. The new-issues market slipped in 1988 and sank sharply to about $14 billion in 1989 amid the uncertainty about equities. What life there was in IPOs in late 1980s came from an unusual source: closed-end investment funds. These management investment companies operate like mutual funds but offer shares that trade on stock exchanges over-the-counter. In 1987 and 1988 initial offerings from these funds accounted for the lion?s share of the market, though by 1989 they, too, were in decline.

During the giant bull market of the late 1990s IPOs were the rage. With new offerings coming to the market on a regular basis, both mainstream Wall Street firms and off Wall Street firms made millions in fees, ending in the Dotcom Crash of 2000.

Since then the end of the Dotcom Bubble and with the recent financial crash, venture capital funding has been much more subdued and will most likely stay that way until the market improves in the future.

Quote of the Week: ?Few men have virtue to withstand the highest bidder.??George Washington

Bart Ward is the chief executive officer of Ward & Co. Ltd. an Anoka based registered investment advisor ? specializing in the management of stock and bond portfolios in companies which are listed on the NYSE.

Source: http://abcnewspapers.com/2012/07/20/the-corner-22/

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