Banks and Venture Capital
Weiner, Lisabeth, American Banker
Banks and Venture Capital: Riches and Risks
While many banks remain fixated with traditional business lines, a small vanguard of institutions has found it possible to strike a rich vein in an area once thought too perilous: venture capital.
Consider the experiences of three major bank holding companies:
First Chicago Corp. had noninterest income of $178.3 million in the fourth quarter of 1985, of which $33.5 million came from venture capital gains on sales of equity securities.
Norwest Corp.'s venture capital group earned $18.9 million in 1985, compared with overall earnings of $107.6 million for the Minneapolis company.
Security Pacific Corp.'s venture capital group contributed pretax earnings of $74 million to the Los Angeles-based company's overall earnings of $322.8 million in 1985.
As commercial lending has become more competitive and less profitable, this small but growing group has found venture capital, with "the sky's the limit' profit potential, worthwhile despite its risks.
"Bankers who look at venture capital as being so risky are only kidding themselves,' says Andrew Kalnow, a partner in Alpha Capital Venture Partners and a former commercial lender with First National Bank of Chicago. "There's nothing more risky than lending money.'
With venture capital, he says, the most a bank can lose if a deal turns sour is its principal. "But as to what you can earn, why, the sky's the limit.'
Despite the success stories, it would be wrong to underplay the inherent risk of venture capital. Industry experts agree that it is not for everyone.
"This business has high potential return and high risk. Some people hear only one of those,' says Z. David Patterson, executive vice president of New England Capital Corp., a subsidiary of Bank of New England.
"The learning curve can be very expensive for those who are just getting into the business. It's not an easy business to learn. Everybody has not been successful. And the risks cannot be overblown. Any investment that a bank would not handle as a loan is a risk,' he adds.
Timothy Hay, president of Security Pacific Venture Capital Group, echoes that sentiment. Everyone knows about the big gains, he says, but there "could also be a large share of losses. This is not secured lending. Your money is very much at risk out there.'
Walter Stults, president of the National Association of Small Business Investment Companies, adds, "I tell banks when they talk to us that a [venture capital unit] for four or five years will look like a loser. Do you really want to put $10 million into it and then just wait?'
"Pearls Take a Long Time'
One reason for the success some banks are now having is the long-term nature of the venture capital business.
Venture capital requires long-term investments and plenty of patience. Industry experts are fond of saying, "Your lemons ripen early; your pearls take a long time to cultivate.'
It is natural then that Security Pacific, First Chicago, and Norwest are showing excellent results. Each has been in the business for more than 20 years. Not only do they have mature portfolios, but they also have highly skilled professionals running their shops.
The banking industry's success with venture capital is well documented. Bank-established venture capital divisions, called small business investment companies, or SBICs, have outperformed other SBICs in recent years.
From 1979 through 1984, total return on invested capital for bank-owned SBICs averaged about 39%. The rest of the SBIC industry averaged about 29%. Bank owned SBICs total only 97 out of 372 SBICs overall, but account for about 50% of the $1 billion in total capital committed, according to the National Association of Small Business Investment Companies.
Banks are so successful because they provide significantly more funding than the rest of the industry, says Mr. …