VCs left holding worthless IPO shares

Keep that champagne on ice.

With skyrocketing IPOs now a distant memory, some venture capitalists are finding their shares underwater by the time they have their first opportunity to sell.

Reports from seasoned firms such as Oak Investment Partners and Crosspoint Venture Partners buck the perception that VCs usually walk away with IPO profits--regardless of whether a stock has faltered in its first months on the open market or is languishing way below the offering price.

That perception is so widespread because VCs usually do get in on the ground floor, buying into a stock at pennies or a few dollars per share. But in recent months, some IPOs have tumbled from their first day of trading, leaving VCs unable to capture the quick profits they were once accustomed to.

By the time they are allowed to sell the shares, usually six months after the public offering, some shares are trading even below that low VC price, handing their firm a paper loss.

Most VCs do not try to sell their shares as soon as the so-called lockup expires, partly to keep from glutting the market and depressing the share price, and partly because of regulatory restrictions on how much can be sold at any one time. In other words, an IPO may be a chance to make some money, but it is not necessarily an exit strategy.

"Even after a first day's trading, VCs still have a lot of work and uncertainty ahead of them," said Steve Lisson, president of InsiderVC.com, based in Austin, Texas. "They are still insiders, investors and board members. And they still haven't made or lost any money on the deal until they distribute or sell the stock, which cannot be done overnight."

On paper, VCs have been having a rough year. Venture firms have had five consecutive quarters of declines, according to research firm Venture Economics. Although they still made money during the first three quarters, they dipped into the red during the last two quarters--leading to an industry record of a 6.7 percent negative return over a 12-month period.

Sooner, rather than later
Poor IPO returns played a part in this 12-month performance. Venture firms have been struggling with the aftermath of paying high valuations for their investments amid a market that has tanked. They are also encountering repercussions from the billion-dollar funds they raised--which forced many firms that typically invest in earlier rounds to put their money to work in later, more expensive, stages.

"A lot of VCs felt there was a window for an IPO and they had to do it sooner, rather than later," said one investor, who recalled his experience during the go-go years. At the time, he was on the board of a health care technology company and was a limited partner in the fund backing that company.

	VC shares underwater Six venture capital firms have suffered paper losses on their investment in Triton Network Systems, which makes equipment to set up high-speed wireless networks. Since launching in July 2000 at $15 per share, the stock has fallen to below a dollar. First-round investors paid $2 a share, second-round investors paid $5 a share, and third-round investors paid $10 a share. Here's how it broke down:
	Triton investors				Total amount invested/round				Net paper gain (loss)
	Oak Investment Partners Total net loss: ($2.4 million)				$2.5 million/first $2.3 million/second $2.5 million/third				$625,000 ($1.1 million) ($1.9 million)
	Worldview Technology Total net loss: ($2 million)				$1.5 million/first $1.4 million/second $2.3 million/third				$375,000 ($692,286) ($1.7 million)
	Advent International Total net loss: ($2 million)				$1.3 million/first $1.2 million/second $2.3 million/third				$300,000 ($618,572) ($1.7 million)
	Bessemer Venture Partners Total net loss: ($1.4 million)				$1.2 million/first $1.2 million/second $1.5 million/third				$300,000 ($612,500) ($1.1 million)
	TeleSoft Partners Total net loss: ($1.9 million)				$2.2 million/second $1.4 million/third				($900,000) ($1 million)
	Meritech Capital Total net loss: ($7.3 million)				$9.7 million/third				($7.3 million)
	*Triton reflects reverse-split that occurred before IPO Source: CNET News.com research and company SEC filings

"When they said they wanted to take it public, I was aghast," he said. "The company was not in a position to have profits, let alone revenue. But they said if Amazon can do it, so could we. As an investor in the fund, I was happy, but as a board member I was horrified."

After the lockup expired, the shares were under water. He later sold some at a small profit but is still sitting on most of them, hoping for better times.

More recently, investors in Triton Network Systems have taken a drubbing. Six VC firms that invested in Triton, which makes equipment to set up high-speed wireless networks, have, so far, had a paper loss of $32.5 million, based on what they invested and what the stock is worth today.

Triton's IPO went out in July 2000 at $15, raising $82.5 million. Since then, the stock has dropped to about 70 cents.

Meritech Capital, an investment firm that bought in during the third round at a pre-IPO reverse split-adjusted price of $10 per share, has had the biggest paper loss: $9.7 million.

"We celebrated when Triton went public," said one venture capitalist whose fund invested in Triton. "But it's been a big disappointment."

When the six-month lockup for Triton ended, the shares were at $2.50, meaning only first-round investors, who paid $2 a share, had the opportunity to make money if they decided to sell. Second-round investors had paid $5 a share.

Other companies that left their investors in the cold were Opus360, which makes software targeting the professional services market, and Fastnet, a Web hosting services company.

Opus360 has dropped off the Nasdaq and trades on the over-the-counter bulletin boards. Crosspoint Venture Partners, which invested in the first and second rounds, had a paper loss of almost $1 million. Shareholders may have one more chance at returns, however, when they get a 20 percent stake in a company created by the expected merger this next month of Opus360 and Artemis International, a wholly owned subsidiary of Proha.

One of Fastnet's backers, H&Q You Tools Investment Holding--now JPMorgan Partners--put in $710,865 at $7.13 a share, but the stock was below that by the time the lockup expired last August. Today, the stock is trading below a dollar.

VCs usually reclaim their investments through an IPO or a buyout. One home-run IPO or buyout can offset losses by other portfolio companies that have folded or operate in a vegetated state, maturing without hope of an IPO or buyout.

"Early stage VCs hope to make 10 times their investment three to four years out" from their initial investment, said Bob Larson, a managing director of the Woodside Fund, a founding member of the Early Stage Venture Capital Alliance.

On shaky ground
But with so few IPOs this year, and with such a cautious market, VCs are on much shakier ground. One of this year's big IPOs was Marc Andreessen's Loudcloud, which launched in March. The VC lockup on that IPO expires Sept. 4.

One Loudcloud investor, Benchmark Capital, put $20 million collectively in second- and third-round funding, for $1.68 and $17.06 per share, respectively. That means Loudcloud shares have to be worth $2.17 for the investor to break even. On Tuesday, the shares were trading around $2, which puts Benchmark's investment in the red by about $1.6 million.

"When we talked to our investors, we think they knew they were in for the long haul," said Scott Dunlap, vice president of marketing for Loudcloud. "The decision to go public had many drivers. There was a booming market and an IPO would be enough to fully fund our business plan.

"We looked at the debt markets, too, but they were performing poorly, and the public markets were starting to come down and the private markets were worse," he said. "We were fortunate to get out when we did, since things have gotten even worse."

But losing money is part of the game for venture capital investors, and the losers do not linger on the bad news. Advent International, which lost $2 million on Triton, links to the company on its Web site as among the investments that went public in 2000.

"One aberrant deal is not a very useful case and point," said Andrew Fillat, a managing director for Advent. "We have far more IPO upside surprises than downside in this regard."

Other Triton investors include Worldview Technology Partners, which had a paper loss of $2 million; Oak Investment Partners, with a paper loss of $2.4 million; and Bessemer Venture Partners, with a paper loss of $1.4 million. TeleSoft Partners had a $1.9 million paper loss, and late-stage investor Meritech Capital had a $7.3 million paper loss from its third-round investment, according to Securities and Exchange Commission filings.

"In general, we're long-term players," TeleSoft founder Arjun Gupta said. "We're not fazed by the ups and downs of the market."

Representatives from JPMorgan Partners, Oak Investment Partners and Worldview Technology Partners declined to comment. Bessemer and Meritech did not return phone calls seeking comment.

Paying back investors with either cash or stock from the company with the stock being under water is never easy, VCs say.

"Distributing illiquid stock to (limited partners) is not a practice that we believe they appreciate," Fillat said. "So the goal is to exit as soon as possible without trashing the value we have."