TEOCO, GlycoMimetics and United BioSource—Private Placement or Acquisition? It is an issue that has interested us for years. When is an investment a buyout and when is it a venture investment? The line used to be very clear. Buyout funds absolutely had to have control, and control was defined as over 50% of the voting stock. In the previous millennium, a buyout fund would run out of the meeting room if official control was not on the negotiating table. Likewise, venture investing was very clear. No venture fund ever wanted anything that looked like control. Venture funds depended upon management to run the company, so they shunned that responsibility. These parameters were clearly defined for limited investors in the initial fund prospectuses. But necessity is the mother of invention. It is universal that there is always more money than there are good deals. In the past decade, the competition for transactions coupled with abysmal industry returns across all of private equity have blurred the lines between buyout and venture. Buyout funds, in an effort to lure closely-held companies, have softened their stance on control to the point where many funds publicly market minority investments as well as partial cashing out founders. At the same time, we have seen firsthand how venture firms will not hesitate to take majority control of companies—even in a first round of funding. The reasons may range from too much money is needed to justify a minority position to needing to take control of a company with too many small shareholders. Key to this industry evolution has been a realization that “control” in today’s world is a far more relative definition than 50%. Funds now understand what public investors and raiders have known for decades—under the right circumstances, with the right financial leverage, and with certain covenants or terms, you can control a company with far less than 50% ownership. October in the Mid-Atlantic was loaded with unusually large investments that begged the question of minority investment or buyout. TEOCO took in $60M from one investor, an investor known to be a prolific buyout fund. But in the press release, this was clearly labeled as a minority investment. Since it was a first institutional round, one can imagine that the founders maintained their 50% majority control, and TA is limited to protecting its investment in TEOCO through financial covenants and normal boardroom pressure. United BioSource is a different kettle of fish. The founders are still in the company, but the investment from Berkshire Partners represents a second massive influx of capital. There are now at least four venture funds eating at the table. With almost $350M invested in the company, the venture funds are the owners, and they are negotiating amongst themselves over the direction of the company. Any single fund may not have control, but collectively their interests are aligned, and they are the owners. It was probably fair for Berkshire to describe its investment as “growth capital,” because Berkshire most likely did not get 50% ownership for its $125M. Nevertheless, you can imagine the strength of its leverage in establishing its investment and in future votes. GlycoMimetics of Gaithersburg just completed its fourth round of funding. The $38M coming equally from five funds adds up to $62M since 2003. After that much capital, who do you think owns the company—venture capital or founders? With GlycoMimetics, the venture funds have known for years that they are owners as well as investors. Like owners, they control board votes, they hire and fires executives, and they set strategy. One explanation is obvious. If you are in a capital intensive industry such as Biotech or Telecom, you may think you are taking on investors, but you are really negotiating with your current or future owner.
