Annex Funds: Good Money After Bad?

Earlier this year, we reported that Kleiner Perkins was raising a series of annex funds, so that it would have available reserves to keep older portfolio companies afloat until the exit market returns. And Kleiner is not alone. Mohr Davidow Ventures is also trying to raise annex funds. So is First Round Capital. So is Tallwood Venture Capital.

Even some buyout firms are getting in on the act, either by raising annex funds, deferring management fees or asking LP permission to do follow-on deals out of subsequent funds.

My big question, of course, is whether or not most LPs will bite? Not on the specific names above, per se, but on the general concept of annex funds. It’s a fairly important issue, as the number of annex fundraising attempts from “brand-name” firms may rival (or even surpass) the number of primary fundraising attempts.

I don’t have a clear consensus yet, as early indications are that LPs are conflicted. On the one hand, annex funds have traditionally under-performed primary funds, leading many investors to believe annex fund investments are throwing good money after bad. The flip side to that, of course, is that the primary fund’s performance might have been boosted by the existence of the annex (without which more the primary’s portfolio cos. might have failed). Flipping back again, an annex fund usually crams down or washes down a primary fund investment. Circles, circles.

Complicating matters even further is the fact that many LPs don’t have much of their own dry powder to throw around. But they do have a little, which means they must decide to go with the devil they know (annex to existing fund) or the devil they don’t (new, blank slate fund).

LPs will obviously take each situation as it comes. What I wonder is if their mental starting point is positive or negative…