Venture capital: overview and investment strategies

¶ … Capital

Opening Summary

It is recommended that Columbia undertakes the first option, by bringing in outside capital in the form of a $250 million fund. The principles will need to continue to focus on domestic telecom, and ensure that they retain as much control over the company as possible. The view that they would need to cut investment banking in order to facilitate this is overstated -- management can be hired to handle that side of the business while the principles continue to focus on direct investment with their newfound funds.

Key Issues

The key decision facing Columbia is whether to continue primarily as a venture capital firm making investments financed by the principles or whether they should bring in outside investors, marking a shift to becoming something closer to an investment bank. Accepting limiteds would change the way that the company functioned in several important ways. The first is that there may be restrictions on the investments, as the limiteds would want some control over the investments, possibly adding a layer of constraints to the investments made by the principles. Related to this might be limitations on creating companies from scratch. This is something that Columbia has done successfully, but is outside of the normal role of the venture capitalist. There is fear that if limiteds are taken on, this type of activity would become more difficult to approve. This flows into hands-on investing, something in which Columbia also specializes. The company has been successful in part because the expertise of the different principles has allowed it to pay greater attention to individual deals. The principles feel that this adds value.

Given these disadvantages, bringing in limiteds might seem entirely unwarranted, but there are advantages to doing so. There were some deals that were simply too big for the company, which was constrained by the wealth of the four principles. When it was unable to handle certain deals, Columbia would miss out on valuable opportunities to improve its bottom line. In the wireless industry, upfront capital requirements can be extensive, so capital constraints are likely to be an increasing problem in the future. The need for greater capital requirements had resulted in the company taking on additional leverage, which of course increased the risk of the firm.

Next Steps

There are a couple of different options available to Columbia. The first is to bring in around $250 million of outside capital, but maintain the existing structures. This would involve winding down investment banking to focus on venture capital. A second option is to start a fund in Russia, with local partners there, to capitalize on that country's telecommunications market. The company could be split under the second scenario into three different divisions. The third option is to retain the status quo, which has generally been successful, but offers limited upside compared to the other options.

It is recommended that the first option be undertaken. There are a few good reasons for this. The third option offers limited upside. As the up-front cost of technology increase for telecommunications providers, Columbia's principles are going to be increasingly unable to meet the capital requirements. So this option is superior to the status quo. The investment banking option can be cut, but I do not feel that it needs to be, especially when the second option involved hiring professional management to run the investment banking arm.

The second option, overall, is too complex to be executed right now. Columbia has been successful because the principles have expertise the subject area and take a hands-on approach. They are the classic "value-added" venture capitalists, whose input dramatically increases the value of the investment. Operating in Russia or South America takes the principles outside of their comfort zones. Within a couple of days of this meeting, the risks inherent in Russia will become apparent, and even if the partners wanted to invest in Russia they would have scrapped the program on account of the financial crisis. South America, of course, had its own financial crisis in 1999.