Warburg Studies Venture Capital Tea Leaves
Stock fund managers spend lots of time evaluating companies after they have issued shares to investors--in fact, that’s about all some managers do. But does it also pay to track firms before they go public?
Warburg Pincus Counsellors thinks so. The New York group recently launched a fund for which it can apply the research it conducts on companies while they’re still in the venture capital stage.
Managers of the new Warburg Pincus Post-Venture Capital Fund thus hope to get a jump on identifying the most promising embryonic firms. They believe that young companies into which venture capitalists have sunk money enjoy an above-average chance of prospering.
“Companies with venture capital backing tend to have good access to capital generally,” says Elizabeth Dater, co-manager of the new fund. “They also tend to have a venture capitalist on board, which means there’s professional expertise behind these companies.”
On average, venture capital-backed firms spend twice as much per employee on research and development than companies in the Fortune 500, and they enjoy sales growth 16 times greater, according to a 1995 survey sponsored by the National Venture Capital Assn. in Arlington, Va.
The fact that venture capitalists--professionals who invest in fledgling firms and provide guidance to management--put money into certain firms but not others is a good screening tool, Warburg Pincus believes. Fewer than half of the companies that go public have venture capital backing.
Warburg Pincus isn’t the only fund company that tracks companies while they’re in the venture capital stage and buys their stock at or about the time of their initial public offering.
For example, T. Rowe Price Associates of Baltimore, one of the first groups to focus on small stocks, runs venture capital partnerships for high-worth investors, and its mutual funds often invest in IPOs, says Rowena Itchon, a company spokeswoman.
But the Warburg Pincus fund might be the first to incorporate the venture capital concept so prominently into its strategy.
It should be noted that mutual funds, including the new Warburg Pincus portfolio, generally can’t invest more than a small percentage of their assets in firms that aren’t yet public. That’s because federal regulations require funds to invest primarily in stocks for which there is a ready market.
The Warburg Pincus fund will buy some stocks when they go public, but in most cases Dater and co-manager Stephen Lurito expect to wait until several months thereafter. That’s because there might be some downward pressure on a stock following an IPO, as venture capitalists often like to unload their investments at this time.
For the most part, Dater says, the companies likely to be held in her portfolio are less seasoned than those owned by the typical small-stock fund. But some will be reasonably large because venture capitalists often inject cash into existing public companies going through a restructuring.
The Warburg Pincus Post-Venture Capital Fund ( 369-2728) debuted Sept. 29 at $10 a share and by Oct. 31 had climbed to $10.69. The fund has $3 million in assets. It requires a $2,500 minimum investment, except for individual retirement accounts and custodial accounts, for which the minimum is $500.
Warburg Pincus Emerging Growth, a sibling portfolio managed by Dater and Lurito, has placed among the top third of small-stock funds over the past five years, according to Morningstar Inc. of Chicago. Both Warburg Pincus products should be viewed as volatile.
Even with this year’s stock market surge, Dater thinks small companies have potential. Since the 1930s, small firms have enjoyed three previous stretches when they outperformed large stocks for about a decade at a time. Dater believes another such cycle started in 1990 and could last through the decade. Most of the past gains achieved by small stocks came during the final, “speculative blow-off” stages of previous cycles, she says.