Private Equity’s Common Bond

Readers often ask why this website, and the PE Week Wire email, covers two asset classes that seem to have little in common: Leveraged buyouts and venture capital.

Part of it is publishing legacy, with Thomson using the (then) flexible term “private equity” as a way to play market cycles. When buyouts were hot, it would cover buyouts. When VC was hot, it would cover VC. And vice versa.

But there is also something much less cynical: Each asset class is funded by the same group of investors. I’m not just talking about the same institutions here (public pensions, universities, etc.), but often by the same investment managers within the institutions. Sometimes they are “private equity officers” and sometimes they’re “alternative asset officers.” At smaller shops they’re just the CIOs.

What this means is that there is an ongoing competition for dollars between buyout and VC firms, even if neither side consciously realizes it. Buyout firms have obviously won the battle in recent years, with four straight years of record hauls. Venture has risen steadily too, but not at nearly the same rate. In fact, it could probably be argued that venture fundraising has increased at a lower rate than have allocation to venture. After all, why listen to pitches from a dozen VC firms looking for $20 million, when who can just plug the same $240 million into a mega-buyout fund?

What I’m hearing from LPs and placement agents, however, is that 2008 could finally be the year in which VCs begin to even-up this tug-of-war. Not in terms of total dollars, of course, but in terms of percentage change over the preceding year. The explanation for this (possible) shift is that the credit crunch has scared LPs silly, and they are worried that those giant checks could soon come back to haunt them. Venture, on the other hand, is being viewed as overlooked, and possibly offering more reward with less risk. Feel free to laugh at that last part – particularly if you’ve seen median VC returns since the Internet bubble – but it’s no sillier than stocking up on mega-funds that club up and charge outrageous transaction fees…

Btw: U.S.-based buyout firms raised $276.7 billion in fund capital last year, compared to $225.6 billion raised in 2006 (itself a record). Of this, $135.1 billion went to funds of $5 billion or more.

U.S.-based venture capital firms raised $34.67 billion in 2007, compared to $31.7 billion in 2006. Here’s some additional detail on the VC figures: FundraisingRelease.pdf