VCs get creative about consolidation

Commonwealth's Mike Fitzgerald gives an insider's look at dealmaking in an exit drought

The exit markets have been slow now for about two years, and that means consolidation. It’s hard to get accurate aggregate numbers for venture-backed acquisitions of venture-backed companies, but Commonwealth VC Mike Fitzgerald says it’s growing more common as firms’ thirst for liquidity grows acute. He says there are three types of consolidation moves, all of which are picking up steam: firesales, strategic grabs of healthy companies, and the more difficult merger of two viable venture-backed companies. In an interview Thursday, Fitzgerald offered VatorNews a refreshingly candid look at VC dealmaking during crunchtime.

MB: We’re seeing more venture-backed companies buying other venture-backed companies. What’s going on behind the scenes?

MF: Well, you have private companies that have been venture-backed, running for a while and they’re seeking liquidity for whatever reason, so they gotta do something, or maybe they’ve just decided to give up. The venture-capital partnerships are typically 10-year partnerships, and it’s typical to get a 1, 2 or maybe 3-year extension on that, so they’re 13 years; they’re finite things. Companies can take a lot longer than that to get in gear and succeed; many times they declare non-success well short of that.

The way I think about this is there are three types of situations that a venture fund can find themselves in. Working from the bottom up to the top, number one is: the investment premise has failed, so the venture firm is giving up. “I gotta sell it. I know I’m not going to get a lot of money for it . Other young companies backed by venture firms are often in the same space.” So they can consolidating that space—maybe capture some more customers, capture pieces of technology, capture a distribution channel—whatever it happens to be, the venture-backed portfolio company can bulk up on its opportunity that way. Usually they don’t have to spend a lot of money.

MB: Any examples?

MF: A company called Antenna Software down in Jersey City, New Jersey, just outside of Manhattan, is in the business of mobile applications for corporations—things like field service, sales-force management—that type of thing—from a mobile perspective. Two of their bigger competitors were companies called Dexterra and Vettro. Each of those companies had between $75 and $100+ million paid into them. The business models were just not progressing, so Antenna picked up both of those for a total of [undisclosed, per Fitzgerald’s request. The Vettro deal has been estimated elsewhere at $2.5 million and the Dexterra deal has been estimated at $18 million].

That was a situation where the venture firms had given up. They knew that they couldn’t get to where they needed to be with those companies, so they had to do something. I like to call it “capitulate.” They gave up the dream: “There’s really not much value here; we can’t make this work; we’ll leave them.” So I think there are a lot of those running around. Usually if you put $75 or a $100 million dollars in, you’ve got a hell of a lot more to show for it than that, so those are two busted companies, so to speak.

That’s the bottom rung; let me go to the top rung. This would be a venture company buying another viable business that bulks up their business in some strategic way—again maybe some technology, maybe a customer base, maybe a channel, maybe a product opportunity—and they pick up smaller businesses to build their business. An example of that would be Reval, which is a SaaS supplier of hedge accounting and valuation services down in New York. They bought a company that was basically the same business with a slightly different spin that was in fact their biggest competitor; a healthy business. The two guys that founded it had been at it for 10 or 12 years and they wanted to retire. So that’s a bolt-on acquisition that was a good acquisition for all parties.

MB: What was the name of the target?

MF: The Company Reval bought was FXpress.

So that’s buying a healthy company. Usually to do those, the private company has to come up with the cash for it. In the case of Reval that was a [undisclosed amount] purchase, so we had to come up with the cash to do that.

The middle-of-the-road thing, which I think is a little bit tougher is where you have two venture-backed companies, both doing OK, but not big enough to get liquid. They aren’t valuable to get anybody excited, they’re not quite what they should be, so people start to think, “Gee, should I sell this? Should I get out of it? What can I do to make it look different, a little bigger, give us more opportunity, etc…” And there you get two venture syndicates often behind those companies, and those marriages are, in my opinion, ridiculously tough to do, because each venture group thinks their baby is beautiful and the other guy’s baby is ugly. So it’s very hard to get those two venture-capital syndicates and the two companies and the two managements, etc, to get together and do a deal, especially since it would likely be a private deal where not much cash changes hands, and that’s one that people dream about all the time, but those are few and far between.

Going back to the causes for this, the cause is really the ages of these companies relative to the age of the venture fund. At some point in time, you gotta get liquid, you gotta do something to get liquid. A lot of these companies have been around for a long time, so you gotta dream up different things to do to get it on a path to liquidity. People are trying to be much more creative than they have historically been.