Conservative Values Guide 2004 Fund-Raising –

The 2004 venture capital fund-raising experience can be summed up in one word: discipline. General partners had it, while limited partners didn’t.

A grand total of 169 U.S. firms raised about $17.71 billion in fund capital last year, according to Thomson Venture Economics, the National Venture Capital Association and VCJ research. That is 54% more than the $11.5 billion that was raised in 2003 for 147 funds. The number could have been substantially larger, but dozens of firms turned down hundreds of millions of dollars to keep their funds at a manageable size. Battery Ventures, for example, received over $1 billion in LP commitments for its seventh fund, but it stuck to its $450 million target.

“I think there may be a bottomless pit of LP interest in venture capital right now,” says a fund-of-funds manager who asked not to be identified. “A lot of it obviously is coming from Europe and even some from Asia, but the real sources are public pension funds and endowments here in America that had stopped investing [in venture capital] after the bubble.”

The year was kicked off by New Enterprise Associates, which held a final close on its $1.1 billion eleventh fund in January. Most of the fund actually was raised during late 2003, but NEA would be the first in a series of brand-name firms to make fund-raising noise in 2004. Others included Kleiner Perkins Caufield & Byers with a $400 million vehicle, Benchmark Capital with two funds ($400 million for U.S. investing and $375 million for European investing) and Sevin Rosen Funds with $305 million.

Oak Investment Partners-classified by Thomson VE as a venture capital firm, despite its focus on later-stage deals, spinouts, PIPEs and LBOs-raised the year’s largest fund. It closed on $1.54 billion in July. The second largest funds, at $600 million each, were raised by Interwest Partners and U.S. Venture Partners.

Every firm mentioned so far in this story raised less for its new fund than it had for its predecessor fund, most of which were closed right before or after the bubble began to burst. In other words, already-overcapitalized LPs last year were largely unable to invest at pro rata levels on follow-up partnerships, thus prompting the LP overhang phenomenon (see VCJ cover story, August 2004). In fact, the squeeze was so tight that several firms with below-benchmark track records were able to hit their fund-raising targets with little difficulty.

“There is so much money out there right now that it’s getting scary,” John Jaggers, a general partner with Sevin Rosen, said in a July interview with VCJ.

Sevin Rosen was one of several firms to exclude public institutions from new fund participation, joining groups like Charles River Ventures and U.S. Venture Partners. Overall, however, it seems unlikely that the disclosure issue had much fund-raising impact, save for extra GP due diligence and extra public LP pleadings. Even Austin Ventures is said to be reconsidering its threat to ban local institutions like UTIMCO from its ninth fund (currently in the market with a $500 million target), so long as Texas legislators pass a proposed bill that would prevent the disclosure of bottom-line data like portfolio company information.

The Year Ahead

Venture firms raised more fund capital in 2004 than in either 2002 or 2003, but market watchers suggest that the elevator ride may be over. A number of strong firms already have offering books in circulation, but not nearly enough to keep pace with the past 12 months. “There are some top-tier and second-tier funds that will close in Q1 or Q2, but it’s not too clear after that,” says an LP who asked not to be named.

Early stage investor Mohr, Davidow Ventures in January closed on $400 million for its eighth fund, and startup firms Union Square Ventures and Shasta Ventures were said to be nearing final closes on their inaugural funds.

At least 10 more firms are expected to raise funds. The biggest names in the market right now are Austin Ventures, Columbia Capital, Granite Ventures, El Dorado Ventures and Draper Fisher Jurvetson. Other firms expected to solicit LP capital this year include Atlas Venture, Delphi Ventures, Healthcare Ventures, IDG Ventures West Coast, Oxford Bioscience Partners, Redpoint Ventures, Menlo Ventures, Sightline Partners (formerly Piper Jaffray Ventures) VantagePoint Venture Partners and Worldview Technology Partners.

“We really haven’t invested in VC funds over the past three years, but we’ve got a short list of about six to eight VC candidates for 2005,” says Greg Turk, director of private equity investments for the Illinois Teachers’ Retirement System. “There are a few recognizable names out there, but the fresher ones might be from new firms that are carving out a specific niche.”

If there aren’t enough attractive venture funds, expect LPs to head to the higher ground of buyout funds. Not only is there less risk, but buyout firms also have displayed absolutely none of the fund size discipline of their VC peers. In fact, it’s been just the opposite.

Going into 2005, the largest private equity fund ever raised was $6.45 billion from The Blackstone Group (excluding a $6.5 billion effort by JPMorgan Partners, which was primarily funded by parent company J.P. Morgan Chase). No fewer than four PE firms are expected to break that record over the next several months: Both Blackstone and Warburg Pincus are working on $8 billion offerings, while Thomas H. Lee Partners is said to be prepping a $7 billion-plus vehicle, and The Carlyle Group is expected to soon close on a new $6.5 billion fund.

LPs turned away by conservative U.S. VCs can also take their money overseas. The European buyout market is expected to be hot this year, with more than a dozen firms looking to raise new funds of at least EURO1 billion (euros).

“Given this situation, significant increases in interest rates or slowdowns in economic activity could result in large problems in the portfolios of a number of buyout funds,” warns Kelly DePonte, a partner with Probitas Partners. “If 2005 might be considered the year of the large buyout fund, it could be that 2006 might be the year of the distressed debt fund.”