Venture Capitalists’ Desperate Search


Is getting people to upload goofy pictures of cats and bad English signs a better business than venture capital? Cheezburger Network, the profitable publisher of “I Can Has Cheezburger?” and other absurd Web sites, recently raised $30 million to expand. That venture capitalists are skirmishing to finance oddball ideas that don’t need their cash is a good illustration of the industry’s problems.

Venture capital’s best returns historically have come from the information technology industry — in companies like Sun Microsystems and Oracle. The trouble is, traditional hot sectors like computer production and traditional software have matured. And the hottest area of growth — consumer Internet firms — doesn’t need much capital to thrive.

Companies like Cheezburger, founded by Ben Huh, need comparatively little cash to get off the ground. Input costs, whether they are servers or Internet bandwidth, continue to fall. The software needed to run Web sites is often available free. And finding customers online can be done in an instant if an idea catches on.

It is simple to start a company using savings or angel seed funds and to finance subsequent growth through internally generated cash flow. That is what Cheezburger did. Of course, venture capital can help supercharge growth: Cheezburger plans to hire extra programmers and introduce other improvements.

The upshot of not needing cash is that entrepreneurs can command huge prices for their babies, as Facebook has done by selling stock to Goldman Sachs at a $50 billion valuation. Others can take money off the table, as Groupon’s founders plan to do with part of the $950 million they recently raised. Though those deals may turn out O.K., it’s hard to see venture capital consistently earning outsize returns if business owners are in the driver’s seat in capital-raising negotiations.

This dynamic partly explains the poor returns of the average venture capital fund. A Cambridge Associates index shows venture capital has returned just 4.25 percent in the five years to Sept. 30, 2010, and negative 4.64 percent over the last decade. Considering the risk associated with start-ups and the need to lock up capital, it is no wonder new commitments to venture capital funds have declined four years in a row. You can has too many moneys chasing too few cheezburgers.

Lifting the Veil

Cargill has validated the rules that govern Wall Street. By selling its majority stake in Mosaic, Cargill, the world’s largest private company, has lifted the veil a bit.

Newly available figures put Cargill’s value at about $55 billion. That is about the same as had been estimated before the Mosaic transaction, using multiples of its publicly traded agribusiness rival, Archer Daniels Midland.

Like many closely held companies, Cargill guards its privacy. But even 145-year-old family-controlled firms sometimes need to turn paper into cash. That is why Cargill has proposed to spin off its $24 billion stake in Mosaic, a producer of potash and phosphates. The event will provide the liquidity desired by the charitable trust set up by the late granddaughter of Cargill’s founder.

The transaction requires multiple financial contortions. These are created to make it tax-free for Cargill shareholders. The company is almost certainly holding Mosaic at a low cost basis, making the tax savings worth as much as $9 billion. To achieve this result requires a recapitalization, a debt exchange, a spinoff and share sales. It will require the wizardry of tax lawyers.

By contrast, valuing Cargill is simple. The charitable trust owns 17 percent of the company. For its portion of Cargill, the trust will receive 110 million shares of Mosaic. Assume that for this exchange, the trust is surrendering its whole stake in Cargill. Those 110 million shares, at Mosaic’s undisturbed price, are worth $9.4 billion. Scaling up from the trust’s stake in Cargill implies the company is worth about $55 billion.

That number sounds familiar. Before the spinoff was announced, one of the only reasonable ways to value Cargill was by comparing it to A.D.M. In the last 12 months, Cargill posted $114 billion of revenue and $4 billion of net income. Applying A.D.M.’s price-to-earnings multiple on Cargill led to a suggested market capitalization of $49 billion. Bankers undoubtedly used some more sophisticated measures like discounted cash flow to value Cargill. But they probably didn’t veer too far from what these cruder metrics spit out. It doesn’t always require a an M.B.A., to solve financial mysteries.

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