Will VC shares hit Wall Street?
If a pack of former Bear Stearns executives have their way, venture capital shares and other private equity holdings will eventually be traded as easily as publicly traded stocks.
The New York Private Placement Exchange, a start-up electronic communications network, or ECN, opened last month and is conducting transactions to test its technology. It plans an official launch at the end of July, said Laurence Allen, CEO of the NYPPe, also known as "Nippy."
According to Allen, 43, the NYPPe could become another stock exchange like the Nasdaq, but one that's focused on the venture capital and private equity markets. Currently, venture capitalists have to wait for a company to go public or be sold to cash out their holdings. By building what is known as a secondary market, NYPPe could become another avenue to trade VC funds, leveraged buyout funds, hedge funds and restricted securities of public and private companies.
NYPPe has good Wall Street pedigree behind it. It has the backing of Knight Trading Group, which clears trades for many online brokers. And Allen, who used to manage fixed income and private equity funds at Bear Stearns, brought former colleagues and other executives from Morgan Stanley, Lehman Brothers and Merrill Lynch to NYPPe.
"We have conducted several transactions to date," said Allen, who noted that two "European entities" made transactions of $50 million to $200 million.
He was mum on naming clients, but it's clear he hopes to bring in business from high-tech companies.
Many companies, including giants such as Intel, got into the venture capital game to cash in on initial public offerings and foster strategic relationships. Intel runs a series of venture capital funds to create an "ecosystem" around its semiconductors. Internet incubators such as CMGI and Internet Capital Group became Wall Street darlings in 1999 based on their venture capital savvy.
But those investments aren't nearly as flashy as they used to be. Now companies are finding their cash tied up in illiquid investments when the funds could be used to boost their business prospects. Numerous companies have already taken write-downs to account for the lower values of their portfolios, and many analysts predict technology companies will eventually have to write down their VC investments.
Financial companies have begun to indicate what's on deck for the tech sector, analysts said. Wells Fargo said earlier this month that it would take a $1.13 billion charge, mainly to write off investments in its venture capital portfolio. The same day, J.P. Morgan Chase told investors that gains wouldn't be able to offset losses in its privately held investments, which could affect second-quarter results.
Allen said other technology companies are likely to issue similar statements. That's why he's making the rounds in New York and Silicon Valley to bring in some clients. He said technology companies are likely to be customers as they rotate struggling venture investments so they don't have to take cash used for operations.
"Corporations carry a lot of these investments on their balance sheets," Allen said. "This is a different effort to turn over strategic investments and use the cash elsewhere."
Here's how a recent transaction worked on NYPPe. An investor in Egypt owned shares of a U.S. venture fund. He found a buyer through NYPPe. Because private equity trades are complicated, NYPPe coordinates lawyers and investment documentation. In fact, swapping documents is the biggest challenge, Allen said. A private equity trade resembles a real-estate transaction more than a stock trade. NYPPe settled the trade in five days once it coordinated efforts with lawyers, but other deals can be more complicated.
Calling all venture capitalists
The idea behind NYPPe is sound--secondary markets have been formed to trade mortgages--but Allen has some work to do to get venture capitalists onboard.
Many venture capitalists pointed out that they either haven't heard of NYPPe or don't know enough about it to comment. VCs also questioned whether NYPPe and other companies could actually close deals like a broker because private equity deals are complicated. One VC said it's doubtful that NYPPe could become "the eBay of venture capital."
Because of the complicated nature of private equity deals, San Francisco-based PrivateTrade.com decided to focus more on the matchmaking aspect of the deals. The company links VCs to swap partnerships and then shepherds the deal through, whether parties conduct business online or offline, a spokesman said.
"This asset class isn't far enough along in its maturity to deal with an online approach," said Erik Hirsch, managing partner at Bala Cynwyd, Pa.-based Hamilton Lane Advisors.
Indeed, Allen got a rocky reception when he pitched VCs at a venture capitalist conference in New York on Tuesday, according to some attendees. Most of the questions revolved around whether NYPPe could make a complicated market liquid.
That reception is why Allen is focusing on corporations to "lead the first wave" of customers.
Robert Manetta, a spokesman for Intel, said the company wouldn't rule out using the ECN at some point, but it didn't have an opinion on NYPPe or its prospects at this point.
Nevertheless, Allen is convinced NYPPe will succeed. He estimated that the private equity market is worth about $2.5 trillion, and if the company can get just 5 percent of it in transactions, it will thrive. NYPPe, which charges an average fee of about 3 percent to facilitate a trade, has 4,000 investors in its network and 184 relationships with brokers.
"The VC industry is still clubby, and introducing an intermediary isn't easy," Allen said. "But there's interest in it, and a number of people are lined up."