Acquiring for Cash

With IPOs out of the question, some venture capital-­backed companies are buying entities for their liquid assets.

Authentica, a digital security software company backed by five venture-capital firms, was in a tight spot last fall. Strapped for cash, with expenses cut to the bone and less than $1 million in annual revenue, it was desperate for additional capital. After searching in vain for a fourth round of outside funding, CEO Lance Urbas and finance director Lynn Wolf found themselves at the end of the summer with no new money and a valuation that had plunged from an April 2000 high of $63 million down to just $10 million.

Going back to their original venture capitalists — North Bridge Venture Partners, Greylock, Norwest Venture Partners, JPMorgan Chase, and the Intel 64 Fund — Wolf and Urbas were presented with an alternative form of cash infusion: an acquisition.

After helping the VCs search for a target among their portfolio of companies, Waltham, Massachusetts-based Authentica was allowed to issue stock for Shym Technology. The struggling Internet-security company had no customers or revenues, but it had about $7 million in cash. Authentica shelved most of Shym’s products, reduced the staff, and gobbled up the $7 million to use in promoting Authentica’s E-mail systems. “We acquired the company primarily for its cash and some key people who could enhance our team,” says Urbas, noting that Shym’s product line “really wasn’t the motivation for doing the deal.” Shym CEO Jim Geary was retained to advise the company part-time.

Buying a company for its cash rather than its business may seem a tad avaricious. But experts say the merger-and-acquisition technique is being used increasingly in the current downturn to gain liquidity at relatively little cost. “If you’re a private company worried about getting capital, it’s a way to issue stock and get cash,” says Tony Jeffries, a partner at Silicon Valley­-based Wilson Sonsini Goodrich & Rosati, which has recently talked to several companies considering deals similar to Authentica’s purchase of Shym.

Venture capitalists themselves often are willing to go along with the approach — if the alternative is letting stagnant investments die on the vine. “These combinations are happening much more often, since they allow VCs to minimize their time and capital exposed,” says Scott Meadow, an entrepreneurship professor at the University of Chicago Graduate School of Business. Himself a 20-year venture-capital veteran, Meadow defines the acquisitions as “sideways deals”: not moving the VCs any closer to their exit strategies, but keeping hope alive for a later return on their investments.

At the end of the third quarter, VCs still had $124 billion locked up in private companies, many with little prospect of growing big enough to yield returns, according to VentureOne, a private-equity research firm. The funds have been able to exit from only 18 percent of the companies they first financed in 1999, while watching 22 percent of those firms go out of business, VentureOne says.

“I would think any VC is looking at these combinations,” says George Hoyem, former managing director at Redleaf Group, an early-stage venture fund. This past summer, Redleaf chose to merge two of its portfolio companies after one had been left at the altar by a public buyer. “We’d much rather have sold the company for a reasonable price or raised capital,” says Hoyem of the portfolio merger. “But we couldn’t do that in a reasonable time frame.” Another of Redleaf’s companies was combined with a private company that a different VC group had backed. Other big-name firms, including Battery Ventures and 3I, have put similar deals together in the past six months.


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