daVinci Capital Group Blog

Let’s do the math. There are well over 10,000 private venture-backed companies in the US alone (over 65,000 WW, per VentureSource, 2011) and many thousands of microCap public companies, many in technology sectors. This results in a target rich environment for daVinci Capital Group. Finding the right candidates starts with both our own “desk research” which we call “outside-looking-in” analysis, but also from “deal flow” referrals from a broad system of contacts, including:

• Extensive personal networks of our four Principals
• Networks of consultants close to us and our staff
• Investment bankers
• Industry organizations, including frequent attendance at industry events
• Advisory firms, including attorneys, accountants and public relations.

Our deal flow network is very strong and results from our many years of experience in these markets. We are not only very well connected to the public markets (for example, through investment bankers), but we are also true Silicon Valley/Tech “insiders” with many years of trust with key venture capital. This places us in an ideal position to learn of opportunities that would otherwise not be shared with general private equity investors.

Our information source base is also very robust and facilitates efficient identification and evaluation of investment companies. And unlike venture capitalists that must evaluate hundreds of business plans before selecting an investment opportunity, daVinci need only evaluate dozens of companies to find good investments. Venture firms also have to sift through privately created business plans and presentations that often hard to evaluate without substantial independent verifications. In contrast, daVinci has the benefit of publicly filed SEC documents that must be completed with audited financial statements and meet stringent standards, such as Sarbanes-Oxley requirements. daVinci also has access to many other sources of accurate financial, sales, market, product and competitive information. These additional sources include databases (e.g., Capital IQ, Nasdaq.com, Bloomberg, Morningstar, etc.) that enable daVinci to concentrate its search in specific industry market segments rich with undervalued microCap companies. From there the Fund utilizes proprietary approaches to focus our efforts on companies that are good candidates for further evaluation.

Thus, daVinci’s approach can more quickly identify good opportunities and complete deeper due diligence in shorter time frames than in the venture capital or private equity worlds. This makes us active, nimble and knowledge-based investors in public companies.

The next biggest challenge to the Venture Capital Industry today is returns…

According to the WSJ, “the softening stance follows the venture capital industry’s decade of poor returns. The average return for venture capital funds fell to 14% for the 10 years ended June 30, down from 34% for the 10 years ended June 30, 2008, largely because the venture returns generated in the first half of 1999 dropped out of the calculation, according to research firm Cambridge Associates LLC.” ⁽¹⁾

This is supported in a 2006 Venture Capital Study where it was shown that a fund with the normal distribution of success and failures but with one IPO could generate top venture quartile Net Internal Rate of Return for its Limited Partners. However, given that same success/failure distribution, but no IPOs (i.e., our recent past and today’s market conditions), but only M&A exits, that same fund might generate only a high single-digit Net Internal Rate of Return for its Limited Partners. More specifically, it was found in an average of 10 deals between 2002 and 2004 that IPOs generated 5-6x cash-on-cash, where “Good Acquisitions” (13 deals) would generate 3-4x and “Overall Acquisitions” (some 80 deals studied) would generate <1-1.6x cash-on-cash ⁽²⁾ – and with investment holding periods ranging from a few years to well over a decade. Further there is the risk of no return on many of the deals in a venture portfolio.

daVinci’s goal is to exceed the traditional top quartile returns of 25% Net Internal Rate of Return for its Limited Partners with far shorter holding periods and mitigated risk. We are targeting cash-on-cash returns of 3-6x on an original daVinci investment, the cash-on-cash return of the portfolio is expected to exceed 3x.

These returns, along with enhanced liquidity, shortened time to exit, and lower failure rates (remember these are established companies – with proven technologies, tangible products and existing customers), should yield superior risk-adjusted returns with overall returns comparable to historic “decade plus” venture capital model. .

(1)    November 29, 2009 Wall Street Journal article titled, “Venture Funds Sweetening the Terms”

(2)    2006 Doll Capital Management Study and others

The biggest challenge to the Venture Capital Industry today is the apparent lack of liquidity…

Stewart Massey an endowment consultant at Massey, Quick & Co. asserts, “… endowments and foundations are going through a period of restructuring where the foremost thing on their minds will be liquidity, even if that means giving up return and taking in some losses.” ⁽¹⁾

However, the traditional Venture Capital Industry has not been able to deliver on solving liquidity needs or addressing ways to mitigate the effects of illiquidity…

But it’s still not a good time for “exits,” as VCs call them, when they reap their returns, despite the uptick in mergers and acquisition and Wall Street offerings. Onset Venture’s Shomit Ghose put it this way: “For private equity, the exit market still feels a little like the Eagles’ “Hotel California”: You can check in anytime you like, but you can never leave.” ⁽²⁾

Overall, venture-backed companies generated $17 billion in IPOs and mergers and acquisitions in 2009, down 34% from $26 billion produced in 2008, according to VentureSource. ⁽³⁾ And already 2008 was a bad year for exits in itself. And while Q1 2010 has seen 8 venture-backed IPOs, the market still seems very fragile to many – while the average 2010 IPO has risen 11%, many of these deals were completed well below their filing range.

And this in turn has affected investor sentiment…

According to the WSJ, “many investors are reluctant to put more money into venture capital, especially amid the liquidity crunch from last year’s market turmoil.” ⁽⁴⁾

Investors, i.e., Limited Partners, want predictability in their investments’ liquidity, this is more important than ever before in these economic times.

This thinking and more has led to the liquidity-oriented investment strategy of the daVinci Capital Group. As seasoned, hands-on venture capitalists with strong operating experience, daVinci’s hallmark strategy in mitigating liquidity risk is to select and actively invest in public microCap companies and to drive strategic growth combinations with other public microCaps and late-stage private companies.

In this way, daVinci provides realizable value throughout the investment process, facilitating earlier and predictable liquidity. As well, by driving these microCaps into smallCap status any potential trade volume limitations are eased which further enhances liquidity. It is important to understand that these are established companies with proven technologies, tangible products and existing customers.

(1)    February 17, 2010 Wall Street Journal article titled, “Harvard Tests Market for Its Property Bets”

(2)    October 29, 2009 San Jose Mercury News article titled, “VC Confidence Flat, but What Does It mean?”

(3)    March 9, 2010, Wall Street Journal article titled, “Venture-Capital Firms Caught in a Shakeout”

(4)    November 29, 2009 Wall Street Journal article titled, “Venture Funds Sweetening the Terms”