KUHN CAPITAL Monday, March 19, 2018
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Regulators Kill Venture Capital


Well, that’s a bit of an overstatement. But Sarbannes Oxley (“Sox”), the layer of mostly useless accounting and control reporting placed on all public companies in the wake of Enron, has figured prominently in the decline of American IPOs since its imposition. It’s not just the irrelevant minutiae that Sox forces companies to report that’s the problem; it’s also its raft of new personal liabilities on officers and directors of public companies, and the cost of compliance.

That cost is typically $1.5 million for any small to mid-sized public company. So when your revenue is $50 million and your pre-Sox net profit is 6% (or less if you’re growing), then Sox means you have no -- or negative -- cash flow. Trying to go public with these sorts of financials either doesn’t fly, or translates into lousy valuations. Having no or reduced IPO options deprives venture capitalists of their already-rare homeruns, and can make their returns unsustainable.

So now comes the Wall Street Journal in a July 19 article entitled “Venture Capital Could Shrivel Away”. It quotes some sad stats: VC funds raised from 1997 to 2007 show an annualized return ranging from 0.3% to -7.7%. VCs raised $33 billion in Q2, 2000, the height of the dotcom boom: in Q2, 2010, they raised just $1.9 billion.

Not all this bad news is the fault of Sox. Other factors include the lack of new revolutionary technologies like the Internet and of course today’s general economic malaise. But Sox sure hasn’t helped and based on its impact, we can imagine how the 2,319-page Frank/Dodd regulatory overhaul will play out – more political scrutiny of ever-diminishing returns. The fact that Frank/Dodd puts a bigger tax bite on VCs when they do manage to eke out a return just adds to the fun.

What’s the bottom line for young, cash-hungry companies? Don’t depend on VCs for your funding.

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