A time-tested adage says the key to the real estate business is location, location, location. A similarly quick and easy description of the venture capital business would almost certainly focus on deal flow, deal flow, deal flow. Simply put, the first step to success in the VC universe rests on investment opportunities. Finding the right opportunity can transform a VC firm from a struggling first-time fund into an established franchise. And becoming an established franchise means industry-wide praise, recognition and the ability to justify to your limited partners the absolute necessity of taking a premium percentage of a vehicle’s carried interest. In short, deal flow is of the utmost importance.
Given the importance of deal flow to success, it is no surprise that in the process of raising funds VCs often stress the uniqueness and quality of their deal flow and their individual ability to source deals through their own personal networks of contacts and friends. A firm located in the Midwest might make a point of how their geographic location gives them something akin to proprietary deal flow on deals coming out of middle America, while a brand new fund founded by two former technology executives will probably point to their domain expertise as a reason they will end up seeing great information technology deals.
While it cannot be doubted that successful VCs spend a great deal of time sourcing deals through internal efforts, it is equally true that these efforts are often aided quietly by the private placement groups at investment banks, who are busy trying to find investors for capital hungry private companies. In fact, more than just aiding, some placement agents at investment banks say they play an integral role in providing deal flow to later-stage VC firms.
“At large, late-stage private equity firms, you might find that a large percentage of the deals they do are agented,” says Albert Bender, managing director of equity private placements at A.G. Edwards & Sons Inc. Mike Mortell, managing director and co-head of private equity at Prudential Securities Inc., agrees with Bender. “I think a lot of later-stage firms look for deal flow from investment banks,” he says.
Placement agents work best with later-stage VC firms because, in addition to an up-front retainer of $50,000 to $100,000, agents charge the companies they represent a fee that is a percentage of the funding round raised by the company. This fee usually ranges between 6% and 10% of the round in question, Mortell notes. Furthermore, since late-stage VCs traditionally invest in larger rounds of funding for more developed companies, it simply makes economic sense for the agent community to focus on late-stage deals, another placement agent says. The fee generated by agenting a small Series A funding round is not worth the effort it requires, he comments.
Placement agents can play a significant role in a late-stage VC’s deal flow because of the value they can add to the process of putting together a round of funding, several agents say. This value comes in a couple of different key areas, they note. One of an agent’s biggest value-adds is simply in managing the running of a fund-raising process for a company unfamiliar with, or unskilled at, raising money, said one private equity banker.
Often times, companies do not really know how to set a valuation or what is standard market practice, he notes. “A real key to making the process successful is going to the buying community with the right valuation,” the placement agent explains, adding that a skilled agent can shorten the amount of time it takes for a company to raise money through his familiarity with the marketplace and knowledge of which VC firms are interested in which type of deals.
Indeed, while placement agents say one of their biggest strengths is their ability to distribute a deal broadly to any and every firm that might be interested in it, the key part of this skill set is knowing what firms want. “I don’t send a book to 200 firms, because firms will stop looking at my books because I sent them something that didn’t make any sense to them before,” says A.G. Edward’s Bender. “But if I have a relationship with a firm, they will do a deal because it fits them and they believe it is at a fair-market price.”
In addition to simply helping a company focus its message and put together the best pitch book possible, Prudential’s Mortell says agents add value because they perform their own due diligence before taking on a private company as a client. This means that a VC does not have to worry about the quality of the company it sees from Prudential, because the bank is not going to take on a flawed company as a client. “We have a tight screen in place now, because investors have become pickier with their dollar,” he says.
An agent’s due diligence should save a VC time when he is evaluating a deal, because the agent is going to be looking for the same qualities in a company that a VC is, Bender notes. “We only do deals for companies with solid management teams, which is something that is also important to VCs, so this helps,” he adds. “We also provide added value in terms of research, because we will look and be able to say how a company might fit into the competitive landscape in its market space.”
Getting a deal from an agent can also be a benefit to VCs when it comes to fashioning an exit strategy for a particular company, Bender notes. This is so because the larger goal of most private placement groups is to place their bank on the inside track to underwrite a company’s initial public offering or advise it later on a merger or sale opportunity, he says.
“It is good for a company to get on the screen of one of our research analysts earlier than they otherwise would,” adds Bender. “Plus, going through the whole process of doing a private placement memorandum with us prepares a company for an IPO.” Another private equity professional says the main reason for his group is to feed his employer’s IPO pipeline.
In February, Corechange Inc. used Prudential as a placement agent to help put together an $18 million, third round of venture funding, notes Hakan Wholin, a former investment banker who is now executive vice president and head of business development at the enterprise software company. “Basically, this meant we outsourced our financial concerns, which allowed us to focus on running the business,” he says. “The devil is in the details with a private placement, and an independent agent is great because he can say this is standard, or this is nuts.” While Wholin describes the fee paid to Prudential by Corechange as big, he says ultimately the guidance and help provided by the agent meant the money was well spent.
When it comes to placement agents, VCs themselves were not of one opinion in assessing agents and the role they play in the marketplace. Some VCs say while they might take a deal from an agent on rare occasions, they simply prefer not to work with agents because it does not fit into their strategy. “There is sort of the hound dog and kennel dog approach in this business,” says Jeffrey Jay, a general partner at Whitney & Co. “A kennel dog stays in its cage and eats what it is fed, while a hound dog has a keen sense of smell and knows what it wants and then goes and finds it. We think about what we want and then go and find it.”
“Traditionally, it was almost a negative thing to work with an agent,” says Jim Boettcher, a general partner at Charter Growth Capital. “But now with bigger and bigger rounds, they can be a help,” he adds. Andrew Fillat, managing director of Advent International’s Global Venture Capital Group, says that while a placement agent can be valuable in guiding the company it is working for through the process of raising money, he does not think the agent adds any real value for a VC. Fillat also says he does not put a lot of faith in the due diligence done by an agent because the agent, after all, is an employee of the seller. “You have to do your own due diligence,” he says, adding “the value a placement agent brings us is in bringing us a deal.”
Bob Grady, managing director of The Carlyle Group’s early-stage venture fund Carlyle Venture Partners says that besides having a stage focus outside of the interest of most agents, Carlyle likes to avoid agented deals because of a fear that they are marketed too widely. “It is very rare that we would do a transaction from a placement agent, mainly because our transactions are focused on areas where we have an edge, but since a deal from an agent is usually marketed widely, it reduces our edge,” he says.
On the other side of equation are VCs who do find a lot of value in the role played by agents. “We have a lot of great relationships with agents,” says Storm Boswick, managing partner at J. & W. Seligman & Co., a mutual fund complex that began doing VC investing at the expansion- and late-stage in 1997.
“An agent is involved because a company does not want to have to spend hours and hours of their time raising capital,” he says. “And this is good, because taking management away from growing revenue and managing the business can have a destructive influence on a business.” Boswick says that about one-third of the VC deals in which Seligman invests are agented transactions.
About half of the deals done by TA Associates Inc. involve an agent or some other intermediary who introduces the firm to a potential portfolio company, says Jonathan Goldstein, a managing director at the firm. “Agents are very valuable,” he says. “They are looking for great companies, too and some of my best deals have come from agents,” he adds. “I sort of consider them almost an extension of the firm.”
Both Boswick and Goldstein say they do some of their own due diligence on all agented deals in which they invest, not because they distrust agents but it is simply good business sense. “Effectively it is a question of building trust,” Boswick says. “If there is trust there with an agent, you can dig into their due diligence and trust it, but in cases where you don’t have that relationship you have to do the primary due diligence, too,” he adds.
Boswick also notes that he is unconcerned about agents marketing deals widely. “I don’t care if an agent has or hasn’t sent the book to the whole country,” he says. “If we do our job and like a company, this is not a competitive threat.”
Can We Talk?
The key to a successful relationship between a VC and a placement agent comes down to communication in the end, both parties say. The goal of this communication should be for the agent to understand a firm’s philosophy and know its partners, says Salem Shuchman, a general partner at Patricof & Co. Ventures Inc. “So this way they can say this is a good match for you as an investor and they can say to the company this is a good investor for you,” he adds, noting “we work hard to maintain our relationships with agents.”
Prudential’s Mortell says the better his group knows a firm’s sweet spot the more helpful it is in knowing what deals to send that firm’s way. “In my perspective, it is great to keep in touch with the VC firms,” he says. “From time to time, they should call us and tell us what is up with them and ask us what is going on with us.”