Small cap start-ups into the hands of longer-term investors

Annie's note: do you think this is a good idea? Offering VC holding (private start-up equity) in the stock market for investors to buy the stock? It seems the VCs want to dump their mistakes into the stock market for small investor like you and I to buy. What do you think?

VCs Look Beyond Wall Street’s Short-Term Mindedness

OCTOBER 8, 2009, 12:57 PM ET

By Scott Austin

When will Wall Street go long?

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The venture capital industry, driven batty by Wall Street’sincreasingly short-term mindedness, may not wait for an answer.

Venture firms depend on a vibrant initial public offering market to sell off smaller companies to institutional investors who are willing to take a long-term position in them. That’s hardly happening anymore. While market regulations and consolidation among investment banks are partly to blame for the IPO sadness, VCs have also pointed their fingers at Wall Street for failing to steer small-cap start-ups into the hands of longer-term investors.

To wit: Accounting and consulting firm Grant Thornton this week updated its November report, “Why are IPOs in the ICU,” that cut to the heart of how market changes caused underwritten IPOs to be closed to 80% of companies. While the updated report is mostly similar save for some revised charts, Grant Thornton does offer this nugget after talking to “key market participants”:

“We have interacted with management and portfolio managers of a number of classic, long-term investment firms, including Capital Guardian, Delaware Asset Management, Kaufman Funds, T. Rowe Price and Wasatch Advisors, that invest in small cap companies. These investors confirm that the current stock market model forces Wall Street to cater to high-frequency trading accounts at the expense of long-term investors, and that Wall Street is increasingly out of touch with the interests and needs of long term equity investors.

“Specifically, we have heard that the quality of research on Wall Street has deteriorated dramatically while, in comparison, institutional investors’ quality of in-house research is now “much better.” We also have heard that more investment oriented portfolio managers are more likely to be treated as “C” accounts (Wall Street may rank accounts as “A,” “B” or “C”; most resources are given to the so-called “A” accounts).”

What is the venture capital industry doing about this? The National Venture Capital Association has been encouraging venture capitalists and their portfolio companies to use as underwriters boutique banks instead of bulge-bracket firms they say largely won’t handle IPOs of $50 million or less, which is what most venture-backed companies need to fuel their growth. This also means connecting with investors willing to hold stock for years instead of flipping it for a quick profit.

Others are taking a more hands-on approach. InsideVenture, for example, was started up last year by venture capitalists to play matchmaker between venture-backed companies ready to go public and long-term institutional buyers. It holds conferences in which these investors can meet one-on-one with the companies and perhaps invest in them before a public offering. These investors benefit by getting a better shot at the kinds of companies whose IPOs in recent years have been steered to short-term traders by investment banks.

It’s unclear, however, how well that effort is working. In March, one of the people behind InsideVenture, Chuck Newhall, a veteran VC and co-founder of New Enterprise Associates, said the firm’s debut conference didn’t attract enough of the buysiders like mutual funds to make it a true hit. This week, InsideVenture sold its business to SecondMarket, an operator of a private-company stock exchange that is also seeking to help VCs liquidate their holdings.

Grant Thornton proposes the industry go further. In its report, the accounting firm suggests creating a parallel opt-in public market that would be regulated but open to all investors like the current stock markets. It would be supported by market makers or specialists who would commit capital, and would be priced in quote increments at 10 cents or 20 cents, which “would bring sales support back to stocks and provide economics to support equity research independent of investment banking.” Further, to discourage day trading, investors couldn’t execute direct electronic trades in the market, instead using brokers who would earn commissions and be incented to phone and present stocks to potential investors.