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ANALYSIS
March 2, 2009
Sagging Index no longer reflects what’s going on in the market, some say, Replacements? Google it, to start.
March 2, 2009
Downward price spiral will actually boost the cost of capital for most companies. CFOS, take note.
March 2, 2009
The latest bailout at AIG could be a preview of how the president will deal with Wall Street.
March 2, 2009
No corporate defaults. Big debt offerings. Percolating CP issuance. Things may be looking up in the capital markets.
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March 17, 2008 12:01 AM ET
VC ALERT Penny Hersher says her start-up's investors were worried.
As many as 20% of start-ups could be holding now-failed auction-rate securities on their books, according to some local counts, eliminating a resource that some may naively have thought was as good as cash. It is a worrisome development in Silicon Valley, where start-ups already pressured by the weak market for “liquidity events” are coming under further strain. Without initial public offerings or M&A exits on the horizon, fledgling companies will need bigger stores of cash to sustain them. If the economy sours further, start-ups will have a harder time raising additional funding rounds, so the money they have now will have to last longer. Some venture capitalists, and at least one prominent Silicon Valley bank that advises the tech community, have expressed concern over the cash management practices inside start-ups, with a particular emphasis on their use of auction-rate securities, or ARS. At a Feb. 26 summit of venture capitalists hosted by Dow Jones VentureOne, veteran investor Ken Lawler of Battery Ventures told the audience that his firm had surveyed some 60 of its portfolio companies and identified 12 that have invested in ARS that currently cannot be liquidated. “I've been in business 22 years, and I've never seen anything like it,” Mr. Lawler reportedly said. “Who'd have thought that triple-A-rated short-term securities you'd invest in would be completely illiquid.... You don't think about it affecting classic venture investing, but here it is coming out of left field, and it hurts.” For years now, ARS have been seen by some as a clever investment alternative to low-yielding U.S. Treasuries or money-market accounts. Because interest rates on ARS are variable, set through Dutch auctions held every seven, 28 or 35 days, they often pay higher yields. “Long-term debt, short-term yield,” is how one bank adviser described the pitch. While there are few hard statistics, the estimate that one in five start-ups took the bait is largely consistent with the 17.8% of public companies that had invested in ARS as of last July, according to a report last week by consultancy Treasury Strategies of Chicago (see “Few Corporate Investors Escaped Damage: Study,” FW, March 10). But while the ARS freeze is painful for large companies with well-established balance sheets, for start-ups, whose lifeblood is cash, it could mean the difference between survival and failure. Start-ups typically keep just three to four weeks of cash on hand to pay their bills. The rest goes into financial instruments. One might think the smart money in Silicon Valley—having already self-selected into the high-risk start-up trade—would be ultraconservative when it comes to cash management. “You overestimate the financial sophistication of a lot of start-ups,” said Penny Herscher, CEO of venture-funded start-up FirstRain. “Often, very young companies don't have a CFO. They'll have a controller or a rent-a-controller, but they won't have a CFO who has done this before. [And] you don't sit at board meetings and ask, "Should I go into a money-market account or an ARS?' You talk about strategic things that affect the business, not the tactical details of the securities that you're using for your cash.” Ms. Herscher said that she didn't put any of FirstRain's $35 million in venture funds into ARS, thanks to counsel she received from Silicon Valley Bank, which has been advising clients against the securities since 2004. But her investors have other portfolio companies that did. And in late February, after auction-rate securities hit the headlines as auctions failed en masse, “I got contacted by all our investors, who wanted to know, "Do you guys have any of your money in ARS?'” Ms. Herscher said. In one such e-mail, a FirstRain investor shared this cautionary tale: “I wanted to make you aware of a situation I've encountered at one of my companies. Unfortunately, the auction-rate securities vehicle was promoted to the CEO by their money manager [as]..."as safe and liquid as money market.' [The company] has $5.1 [million] invested in auction-rate securities [and] has three weeks of cash available in a money-market account that is liquid but will need more cash if the illiquidity in auction-rate securities continues. [We] are pursuing loans at both Silicon Valley Bank and Comerica collateralized by the auction-rate securities. However, I don't know if we can accomplish this action.” If this young company can't get new loans, it soon won't make its payroll. “ARS were heavily marketed by brokers telling [clients], "They're safe and liquid.' But they're not,” said Adam Dean of Silicon Valley Bank's asset management unit. “Brokers had to fill the seats of the [auction] stadium every week or month. When buyers wanted out, they had to go find more. It was not unlike a Ponzi scheme.” Nevertheless, a lot of start-ups bought into it. “For firms with more than $10 million in raised capital,” Mr. Dean said, “we've found the percentage of them invested [in ARS] definitely gets higher” than the 20% currently estimated. FW
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