The exit environment is tough. Private equity to the rescue?

By Erin Griffith , written on January 3, 2013

From The News Desk

Venture capital and private equity firms may structure their funds the same and seek comparable returns, but their business philosophies and strategies couldn't be more different. Now they're helping each other out.

The two groups have always had a little asset class envy. In the late 90s, many private equity firms crept into VC territory and, after losing their shirts in the dotcom bust, quickly retreated. In the mid-00 buyout boom, VCs crept upmarket into "growth equity" territory, doing recaps, carveouts and old-fashioned leveraged buyouts in addition to their traditional Series A through D fundings. But most venture investors aren't rushing to identify themselves as Mitt Romney-fied corporate raiders. (There is a middle ground: Buyout shop Accel-KKR is exactly what it sounds like -- equidistant from venture capital firm Accel and massive buyout firm KKR.)

Now, rather than compete, they're helping each other out: Venture capital portfolio companies are increasingly selling to private equity firms. According to Dow Jones VentureSource, buyout deals for VC-backed companies increased 50 percent last year, with buyout firms shelling out $2.9 billion for 30 VC-backed companies.

IT, business services and financial services companies drove the deal activity; the sectors made up 73 percent of deals.

The best explanation for this phenomenon starts with the IPO market. It sucks for tech companies. While last year was technically the biggest year for IPOs since 2000, when you note that 61 percent of the $11.2 billion raised came from Facebook it becomes a little less positive. IPOs in the fourth quarter were down 48 percent year-over-year. While Workday and LinkedIn have fared fine, Groupon, Zynga, and Facebook seem to have killed investor demand for tech stocks. Marc Andreessen calls it a tech depression. What's worse, M&A wasn't too hot, either: even with the new culture of acqui-hires, strategic exits for VC-backed companies were down by 24 percent over 2011.

So, mix a difficult exit environment with the fact that VCs are holding onto their investments for longer, aka "letting their winners run," and you have the current situation: Private equity is funding more of venture capital's exits.

These companies are no spring chickens: The median age of the acquired companies in 2012 was 12.6 years old, and their median hold time for the investors was 9.4 years, butting right up against the life cycle for a VC fund. By the time these companies finally do sell, they're presumably much healthier, more mature companies, possibly ready to take on a little leverage, private equity-style. Over half of the companies that sold to private equity firms were generating revenue and 47 percent were profitable, according to Dow Jones.

And if they aren't healthy, like in the case of LivingSocial, they could still be private equity material. Buyout firms love a good turnaround story.