Investment & Financial Articles
Title: Venture vs Vulture Capitalists
Author: William Cate
Article:
Venture vs. Vulture Capitalists By William Cate Published July
1999 [http://home.earthlink.net/~beowulfinvestments/]
[http://home.earthlink.net/~beowulfinvestments/globalvillageinves
tmentclubwelcome/]
In the last issue of EFS (V3#10), my Venture Capital article
reflected the current experiences of three small Silicon Valley
companies. My article generated comments from four Venture
Capitalists. In essence, there are Venture Capitalists and there
are Vulture Capitalists.
Venture Capitalists fund one company in every 2,500 companies
that query them. Their preferred exit strategy is the private
sale of the company. They are willing to hold their equity in an
investment for years. They believe that they bring management
and financial skills to the company that will enhance the
company's probability of success. If two-of-seven investments
(29%) succeed, they make money.
Vulture Capitalists fund one company in every 100 companies that
query them. Their preferred exit strategy is to take the company
public. They intend to recover their risk capital quickly. They
bring sales skills to the company. Their goal is to make money
on every investment.
I've come across Vulture Capitalists offering toxic
convertibles. They act as Merchant Bankers offering bridge
financing. They offer secondary Private Placement financing to
high flying, usually Hi-Tech public companies.
The Merchant Banking loans require the repayment of the loan and
interest from the underwriting. The Merchant Banker demands a
large bloc of free stock for making the loan. The Merchant
Banker dumps the stock quickly into the Market. About two years
ago, the SEC moved to stop this practice. Any outside party
considering doing Bridge Loan financing for a bloc of stock is
asking for trouble from the SEC. Without the stock incentive,
the bridge loan is too risky. After all, only half the IPO's are
underwritten. Unless you are the underwriter, you can't be
certain that the underwriting will happen.
A Convertible Debenture (CD) is a loan that can be converted
into shares of the public company. If the lender loans the
public company a million dollars at Prime plus 3, they will make
a profit. A CD loan allows the lender to convert the loan into
shares of the company. If the CD allows the loan to be converted
at $4/share and the company's share price goes to $10, the
lender makes more money on the stock sale than from the
conventional loan. Convertible Debentures are popular in Canada
because the stock issued is free trading. They haven't been
popular in the States, because the lender gets restricted (144)
stock.
Toxic Convertibles are Convertible Debentures with an
unspecified exercise price for the shares. The lender can
convert the stock at the current trading price of the shares.
This allows the lender to sell short the stock against the CD
while recovering the loan and interest. The short sale of stock
depresses the company's share price. The lower share price
allows the lender to sell short more stock. It's a downward
cycle for the public company's stock. The CD is used as
insurance against an upward surge in the company's share price.
The Toxic Convertible lender can't lose.
If a public company does a toxic convertible, by the time they
repay the loan, their stock is trading for pennies a share. The
public company fails and the lender makes a multiple of the
principal of their loan.
The moral of this story is that public companies should be wary
of Vulture Capitalists. Read and understand every word of every
Agreement, before you sign it.
To contact the author: Visit the Beowulf Investments website:
[http://home.earthlink.net/~beowulfinvestments/] Or, visit the
Global Village Investment Club Website:
[http://home.earthlink.net/~beowulfinvestments/globalvillageinves
tmentclubwelcome/]
About the author:
He has been the Managing Director of Beowulf Investments
[http://home.earthlink.net/~beowulfinvestments/] since 1981 and
is the Executive Director of the Global Village Investment Club
[http://home.earthlink.net/~beowulfinvestments/globalvillageinves
tmentclubwelcome/]
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