Wednesday, November 18, 2009

What's up?

This article is intended to raise questions rather than to answer them. So, please read on and let me know what you think.

I have been pondering for some time the question of whether there is a sea change underway: The emerging role of varying forms of "rolls ups" as a more frequent exit for growth technology firms. For so many years, management teams focused on the IPO and public company acquisition as the primary exit strategies - then IPOs went away (they're creeping back, some say), but M&A continued to provide excellent outcomes for entrepreneurs. In the past year, the options for small companies seeking an exit have gone from bad to worse. Exit multiples (of trailing sales) have been comparatively horrible for most.

Enter the roll-up as an alternative exit for early stage companies. I define a roll-up as a company forming a core set of products, technologies and access to markets through small, targeted private mergers or acquisitions. Roll-ups can be led by public companies, often Private Equity (PE)-backed; By private companies with often major PE or Venture Capital (VC) backing; By VC firms seemingly focused on completing a whole product offering in a market as a core investment strategy; or directly by Private Equity firms themselves.

So, what's the difference between a PE firm and a VC firm? Many traditionally VC companies are acting more like PE firms, and vice versa. Strictly speaking, VC is probably a subset of the PE asset class which includes venture capital, LBOs and later stage investments. Historically, VCs have provided higher risk equity for early stages and PE firms have led mezzanine rounds in more mature companies. Those lines have blurred significantly. Is this the result of increased competition in equity financing markets caused by oversupply? If that is true, wouldn't that increase valuations seen by entrepreneurs? I have not seen that, although things have certainly improved in the past few months. Are those related?

So, I am left with several questions to ponder. I have my own theories, but would appreciate any thoughts on them that you can offer:
  • Is this a sea change, maybe just a natural result of the recent economy, or nothing at all?

  • In the past, combining growth VC firms with solid teams and powerful VCs was near impossible. Must that change for this to work? Is it changing?

  • Are VC/Preferred board members considering PE exits more these days?

  • I've heard the "they pay low multiples" concern largely ruling out the PE category in the past. Is that changing?

Of most significant concern to me is the effect, if any, this change has on how venture firms approach fundraising? How does this change the way in which CEOs obtain capital if many VC firms are still pessimistic about PE-funded exits, or are resistant to lose some control to a larger group of investors, different management teams or new board members? Of particular interest to me is how this changes alliance strategies for growth companies if their more likely exit is no longer IBM or Oracle, but Thoma Bravo, Attachmate, Brazos or Blue Coat?

I plan to assemble what I gather from this quest into this blog and continue this discussion here. Please join in.

Happy Thanksgiving to all!