Small World (Private Equity Central Net)

 By Marc Raybin, Editor in Chief

"Bigger is better."

That saying may be true for some things, like football players and birthday cakes, but not everyone buys into that truism.

"If you look at the economics of around how venture funds operate, the observation is the larger the venture fund is, the more dependent that venture fund is on a larger exit in order to generate returns," explains Robert Ackerman, managing director and founder of Allegis Capital. "That plays against the backdrop of a dearth of IPOs or, at a minimum, the unpredictability of IPOs."

Ackerman contrasts that to smaller sized venture capital funds, like his. He says managers of smaller funds have more control over their ability to generate better returns in terms of the multiples times investment. That's because these returns can be generated through smaller exits than what are needed by the so-called mega-funds.

"It's not rocket science," he says. "It's just math."

Ackerman is not alone in his assessment when it comes to the beauty of being a smaller venture capital fund.

David Jones, chairman and managing director of Chrysalis Ventures out of Louiseville, agrees.

"If you do not have to put that much capital to work and you can focus on less capital-intensive businesses, you can drive good venture returns without a huge IPO market," Jones says.

Even in a crummy market, you can find buyers at a good price. Chrysalis has had two exits at more than $150 million each since the market tanked more than a year ago. That's pretty good for a firm that typically invests in companies needing only $10 million to $20 million in equity.

Ackerman is a seed and early stage investor. He focuses on companies that are typically in the idea stage. Looking out as many as eight years, Ackerman does not have the luxury of banking on a robust IPO market. Rather than rely upon the up-and-down nature of the public sphere, Ackerman looks to other avenues.

In fact, Ackerman operates with the assumption the IPO market simply does not exist. If he takes out of the sphere of possibilities, then he is free to concentrate on other avenues to exit.

"Our contention is that with smaller funds, where you are more disciplined with valuation, where you are more disciplined around the things you are investing in, you can generate returns from M&A exits," says Ackerman. "The job at the end of the day is to consistently generate returns."
Managers like Ackerman and Jones can afford to have the smaller exits that mega-funds cannot afford to do.

Ackerman does not think there are sectors in particular that are better served in the small market than being in the larger market, however, he does point to several capital-intensive spaces that are particularly hard hit when the IPO market is weak. Telecommunications, semiconductor, and equipment tend to require more investment than do other sectors.

Having said that, there are downsides to being smaller. Jones says small firms do not get rich off management fees. The return is in, well, the return. That is not such a bad thing, he says, as the interests of the general partners are aligned with those of the limited partners.

"Venture is clearly an environment where small is beautiful," Ackerman says.