VCs dodge auction rate bullet

Venture capital investors say they’ve all but dodged a bullet from the lack of liquidity in the auction rate securities market, which has sent chills through Wall Street.

“When this news broke, everyone went through their portfolio to figure out what to do,” says Globespan Capital Managing Director Venky Ganesan. “They had to decide to sell it to an arbitrage business, or hold on it. It’s reminded everybody to really look at our investment policies.”

When Ganesan looked at his portfolio, he didn’t find any company with auction rate securities on its books. He says it was a matter of luck. “A lot of our companies bank with Silicon Valley Bank and they’ve really made sure that everybody stays out of this. People who have banked with other banks might have more of a problem. We knew immediately that there’s no crisis because none of our companies have come up asking for more cash.”

Auction rate securities are long-term bonds that are periodically bought and sold to reset interest rates. Some brokers have pushed these bonds as an alternative to cash, touting higher interest rates than comparable money market funds.

The credit crunch and national economic slow down have dried up the market for these bonds, sticking some companies with illiquid long-term, often municipal, paper. Though there is little question that these bonds will be paid off in the long term, the lack of liquidity in the market is putting some companies that need cash up against a wall.

Sanjay Subhedar, a general partner at Storm Ventures, began talking with his bankers about auction rate securities in February. They pointed out that all of the firm’s money was in money market funds, which the Securities and Exchange Commission prohibits from investing in auction rate securities.

Just one of Storm’s portfolio companies was exposed, Subhedar says. An executive from the startup wrote to Subhedar advising him that it had $525,000 tied up in auction rate securities from a long standing policy of investing in them. The company had another $5 million in cash in the bank and did not anticipate any liquidity crisis.

Few investors PE Week spoke with expressed concern about the financial problems associated with auction rate securities: Lightspeed Venture Partners General Partner Jake Seid says, “It hasn’t impacted us.” New Enterprise Associates Partner Patrick Chung says “we’ve not seen any related difficulty.”

Even firms that have companies with exposure haven’t seen any particularly adverse affects. Granite Ventures General Partner Len Rand says that a few of his companies held auction rate securities, but that they “haven’t needed access to their money on a schedule that affected them.” The banks that brokered those securities have stepped in to cover the companies that had the most exposure, he says.

Joe Morgan has pushed his clients out of auction rate securities since he arrived as the head of portfolio management at SVB Asset Management, an affiliate of Silicon Valley Bank. “When I joined in 2004, we owned some auction rate securities and the first thing I did was sell those in case there was a liquidity crisis on Wall Street,” he says. “For our clients who value liquidity over and above return, it didn’t make sense to restrict our holdings to a single Wall Street broker who brokers these transactions. We’ve been recommending against this since 2004.”

Still, for the past three weeks, Morgan’s group has gotten three or four calls a day from public and private companies looking for advice. These companies bought auction rate securities from someone else and have turned to SVB Asset Management for advice.

“The few calls we’ve had are not a tsunami, but it’s a significant number,” he says.

Venture capitalists are also calling Morgan. About two or three call him each week concerned that their portfolio companies might hold auction rate securities. Others call to see what can be done about the auction rate securities they hold their personal wealth in.

Morgan’s advice has been simple. Stay in contact with the broker who bought the auction rate securities for your company. That person will be in the best position to help you stay liquid at the same level you bought in at, he says. He also recommends maintaining sell orders at each auction date just in case the market does reopen.

Morgan also recommends rethinking your relationship with your money manager.

“Mostly, you will find that the people who have been pushing auction rate securities are brokers, primarily because the securities pay high commissions,” he says. “Corporations thought that they had a relationship there where the broker would look out for their best interests. However, there is no level of fiduciary duty there.”