In a move that could have a domino effect on the rest of the venture industry, ComVentures has informed its limited partners that it is reducing the management fee on its latest fund by 0.5%, sources say.
ComVentures, based in Palo Alto, Calif., made the decision in the fourth quarter of last year, and it went into effect Jan. 1, according to multiple sources familiar with the situation. A partner with the firm declined to comment, citing the confidential relationship ComVentures has with its limited partners.
The firm reduced the fee on its fifth fund from 2.5% to 2%, multiple sources say. That means it will draw down fees of $11 million instead of $13.75 million annually from its $550 million ComVentures Fund V.
The move is almost certain to put pressure on other large early-stage funds to adjust their fees. “A few funds got away with going as high as 3% and a 30% carry, but funds are now returning to historical levels of 2% and 20%,” says John Montgomery, who is co-chair of the venture capital practice at Brobeck, Phleger & Harrison LLP.
The primary force behind this emerging trend is a continued inability, and occasional unwillingness, of venture firms to put their capital to work. ComVentures Fund V, raised in 2000, had only invested 23% of its fifth fund at the end of 2001. Perhaps an even more distressing fact for LPs was that the fund participated in just six venture deals last year, including follow-on rounds.
“We definitely think that some of these larger funds are taking much longer to deploy their capital than they expected and should reduce their fees,” says one insurance firm fund manager.
An alternate method of appeasing LP unease was demonstrated two weeks ago when Mohr, Davidow Ventures (MDV) announced that it was scaling back its seventh fund by 20% to $678 million (See Private Equity Week 1/28, pg.9), sending a message to the industry that it’s difficult to put money to work these days.
“I’ve brought up the issue of reducing fee size or fund size with lots of firms,” says a West Coast-based institutional investor. “I’ve also had some other LPs talk with me about really pressing certain GPs to lower management fees, but I’m not sure anything will come of that.”
The pressure from LPs may be working more than he thinks. A general partner at a venture firm with more than $1 billion under management confirmed that he and his partners are talking to LPs about a fee reduction.
In that particular case, the firm is considering the reduction to avoid being hit by a clawback several years from now. Under a clawback, a general partner of a venture fund must repay any carried-interest distributions it took during the life of a fund if the fund is in the red at the end of its life.
The partner at the mega-fund says the firm has calculated it may owe up to $10 million in a clawback on a particular fund. The management fee reduction on that fund would be the equivalent of giving back about 20%, or $2 million. If it turns out that the fund in question ends up making money, then the LPs would have to repay fees to the firm’s general partners.
The fundamental issue at play is placing a realistic value on the firm’s portfolio, the partner says. “One constant refrain we’re hearing from LPs is that GPs are being extraordinarily slow in taking write-downs,” he says. He estimated that “95%” of all investment managers are over-distributed, and they’re “not being real with themselves or their LPs” if they don’t face the fact that funds raised and invested in the past couple of years are being carried at unrealistic values.
Such fiscal dishonesty, however, cannot go unabated. At some point, LPs will recognize that they are not receiving what was promised when they originally agreed to 2.5% or 3% fees. Once that happens, general partners will have little chance of getting return buyers for new funds.
“The real issue in this market will be raising the next fund,” Brobeck’s Montgomery says. “A venture firm’s most valuable asset is LPs and if you don’t have happy LPs, you’re not going to raise a next fund. You’ve got to do everything you possibly can to make that very difficult job as easy as possible.”
A large Silicon Valley VC is rumored to have had internal discussions over whether or not to tie a capital giveback to a promise for future fund participation. Such an arrangement would most likely be informal, but most LPs contacted for this story gave it little chance of succeeding.
“I’d be hesitant to blindly make a commitment to a future fund,” says Paul Yett, a vice president with Hamilton Lane Advisors. “For starters, you can’t even be sure who the senior leadership of a firm is going to be 10 years down the road.”
He did say, however, that the general issues of over-committed capital and high fees were on the minds of many LPs. “I haven’t yet been approached by any of the firms in my [portfolio], but there is always the concern in the market that some of these funds were too large,” he says.
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