Venture Capital vs Financial Private Equity Investments

It bears repeating that American capitalism is at a crossroads. There is a coterie of financier and investors primarily of the private equity and hedge fund kind that are taking advantage of historically low interest rates and banks willingness to allow for and finance hugely leveraged (the private equity stake is typically less than 15% of total invested capital) buyouts of weakened but still viable companies (low debt to equity, still profitable but waning, often caught in the technology-change headlights). These are the new low risk, high personal return financiers who have found a very low risk money making machine for themselves and “friends”. Think KKR, Clayton Dubilier Rice, or the BlackStone Group (see here for a partial list of large scale private equity shops).

Now some of these private equity operations – lets call them venture capitalists, have been thriving for 30 plus years and are distinctly different from the financial private equity firms. These venture capital firms invest in technology start-ups first in computing, then software and Internet, and now more broadly in biotechnology and alternative energy ventures. Think of Kleiner, Perkins, Caufield & Byers or Sequoia Capital. The essential difference is that venture capitalists are investing in new firms and new technologies. These investments come very early in the startup process and typically have 2-3 rounds of increased capital investment. The whole idea is to help shepherd new technologies onto the market with financial, start-up and managerial skills that the nascent firm may be missing. Another key difference is that venture capitalists are creating jobs and often whole new industries. Unlike financial private equity shops, venture capitalist are not saddling firms with high debt burdens,  slashed  staffing,  short-term cutbacks and/or new capital starving-diets. Finally, the risk exposure of venture capitalists is much higher – there ventures can belly-flop or just take a long time to mature. Inherently, because venture capitalists are indeed creating new capital ventures they bear much greater risk than financial private equity firms whose takeover formula guarantees that their risk is minimized right from the outset of a highly leveraged buyout – and then huge increases in the new corporates debt load as initial financing is paid off under the privacy umbrella.Divisional sell-offs and manpower cuts are made to further reduce risk exposure. The whole goal is to make huge amounts of money quickly for the financing private equity firms.

The net result is that the US, long cited as the most venturesome of business capital economies is now ceding that pre-eminent position to the Brazil’s, China’s, and India’s of the World as the country’s financial powers and wealth is devoted to more “sure-thing”, low risk financial private equity ventures. And the evidence is clearly on the table. Look at 3 huge emerging markets – and the lack of major partcipation by US firms and Capital.
1)Non or lower oil-based transportation particularly cars, trucks and planes. Only Boeing has made a major investment in reduced energy usage – and despite the technology hiccups is still doing well against Airbus and other competitors. As for the US car and truck industry – the best that can be said is that it is scrambling to catch up;
2)Alternative, less-carbon, less dangerous-waste energy sources. US companies have succumbed to the lure of sure-thing 40% ROI typified by oil investments or low risk coal/gas fired energy sources rather than embarking on grid changing investments in wind, solar and other clean sources.
3)Rampant increases in health care costs. US companies have declined from 85% coverage of health costs to less than 60% in less than 20 years  while the cost of care has grown at 2-3 times  inflation rates during the same period. Health care is now closing on 20% of GDP. This is a huge opportunity waiting for smart investments in basic health infrastructure.  The problems are often wicked and the role of government is inevitably large.But so far investments have been very mixed with good intentions being overwhelmed by quarterly earnings requirements.

So the US capital markets have shifted to short term and me-first formulaic, low risk financial investment. The country that brought the world the most vibrant venture capital markets at the close of the 20th Century has seemingly ducked into the sure-things world of financial private equity and hedge funding investments. Could it be that the billion dollar++ salaries at the top of private equity and hedge funds firms  and their  other huge personal payouts have tipped the scales definitively towards low-risk, “sure thing” US capital markets ?  

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