Flow from pension funds likely to slow

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Flow from pension funds likely to slow

As retirement plans controlled by employers decline, venture capital cash expected to wane

By Arden Dale

Dow Jones Newswires, August 11, 2003

NEW YORK -- Venture capitalists aren't hurting for cash, but a retirement trend might help change that down the road.

Pension funds are a major source of venture capital, pumping money into private equity through defined-benefit plans, which leave investing to the employer.

But such pension plans are on the wane, losing out to 401(k) plans. These plans mean more cash flow to stocks and bonds, rather than venture capital. The reason: 401(k)s and other plans that allow individuals to invest aren't suited to the long-term strategies of venture capital.

"Now we're seeing a shift from defined-benefit plans to defined-contribution, so some of the pension funds that have been long-term investors aren't in as much of a position to make the 10-year or so commitment that it takes to invest in venture capital," said John Taylor of research at the National Venture Capital Association.

There are no rules that specifically bar 401(k) plans or other defined-contribution plans from investing in venture capital, according to Dallas Salisbury, chief executive of the Employee Benefit Research Institute, a nonpartisan research group.

But Salisbury agrees with others who say the plans aren't a good match for venture capital.

The main reason is that venture capital deals are structured over a long period, while 401(k) plans are full of individual investors who might need to get out of an investment quickly.

"One of the primary provisions of the defined-contribu-tion plan is that once you walk out the door, this money is yours," said Louis Finney, a principal and senior consultant at Mercer Investment Consulting. "I don't think companies are very interested in the headaches and hassles that illiquid securities would bring to that."

Specifically, a venture capital fund agrees on a total investment to be made by a future date, with specific cash infusions slated for intervening years.

For example, a fund could decide to invest a total of $500 million by 2010, with a cash call of $50 million in 2004, another $50 million in 2005, and so on.

Traditional defined-benefit plans are a natural match for venture capital. These pensions, which guarantee a fixed benefit, are mostly sponsored by old-line companies with strong unions, and have a long investment time horizon.

The number of defined-benefit pensions peaked in 1983, when U.S. employers sponsored 175,143 of the plans. Defined-contribution plans, which include 401(k)s, have increased steadily, according to a recent Employee Benefit Research Institute report.

Companies sponsored 56,405 defined-benefit plans in 1998 (the most recent year for which the data were available) compared with 300,593 corporate 401(k) plans, the institute reported in June.

It's not that venture capitalists will soon cry poverty.

"There are still well over $1 trillion in private defined-benefit plans alone, because the large companies still have defined-benefits," Salisbury said.

Even if a company with a big defined-benefit pension froze the plan tomorrow, it would continue to invest for years out to cover promised benefits, he added. Ironically, current tough times for defined-benefit plans might actually keep cash flowing to venture capital.

Last year, the plans began showing funding shortfalls for the first time in nearly a decade. The bear market eroded assets, just as low interest rates caused plan obligations to balloon.

As a result, many companies have had to contribute hefty sums to their plans: General Motors Corp., IBM Corp. and Ford Motor Co., for example, pumped billions into their defined-benefit pensions at the end of 2002.

Big pension infusions likely will include a share of money to go to venture capital, consistent with the overall plan allocation to the asset class, according to Mercer's Finney.

That means underfunding could help slow down the 401(k) effect because it promises to be a problem for some time to come.

But there's another factor that could affect how many pension dollars venture capitalists receive. Lately, public pensions, which represent government employees and teachers, have been releasing performance and investment data that draw back the curtain on information most venture capitalists prefer to keep private. There has been grumbling by some firms that such disclosure makes public-pension money less attractive.

"There are probably more VCs that like to take money from the corporates than the publics, because the latter have more onerous oversight, and that's where a squeeze could come in," said Jesse Reyes, vice president of Thomson Financial Venture Economics. "As the corporates move away from defined-benefit plans, private equity could be stuck between a rock and a hard place."