False Alarm? Disclosure has not led to the market ruin predicted by many VCs, but that does not mean the debate has been much ado about nothing. Disclosure has already caused negative results f –

This month, an Alameda County Superior Court judge will reconsider an earlier ruling that the University of California must abandon its “you can ask, but we won’t tell” policy toward private equity disclosure.

Judge James Richman found on July 24 that public interests outweighed private interests in the case, adding that UC had failed to adequately demonstrate any foreseeable damages that would result from overriding confidentiality clauses in the school’s private equity fund partnership agreements. For proof, Richman cited the University of Michigan’s recent ability to gain admittance into an oversubscribed fund from Sequoia Capital, even though Michigan already had released the same type of top-line performance numbers requested of UC.

Mind you, UC is far more than a typical defendant posturing in the face of an unfavorable ruling. To support its “motion for reconsideration,” it points to Sequoia’s change of heart about the University of Michigan, citing an apologetic eviction letter penned by Sequoia’s Mike Moritz.

“We have concluded with great regret that we must remove the University of Michigan from Sequoia Capital XI and would request that you use your best efforts to sell off all the University’s positions in other Sequoia Capital partnerships,” writes Moritz, a general partner with the Menlo Park, Calif.-based venture firm. “As you know, we are very concerned that the University will release confidential fund information to parties who have requested it under the Michigan Freedom of Information Act.” Neither Moritz nor other Sequoia partners responded to repeated requests for comment.

It is entirely possible that Sequoia’s letter (see page TK to read the full text) may lead Richman to reverse course. After all, he may decide it best serves the public interest to allow pensioners to participate as investors in top-tier funds than to simply give the public access to performance information about those funds. On the other hand, Richman may rule that his initial decision was more closely focused on trade secret law than his written ruling would suggest, and that he still sees no reason why performance data from Cambridge Associates (an independent consultant hired, in part, to calculate IRRs for UC) should receive a trade secret exemption under the California Open Records Act.

No matter which way Richman swings, the most significant verdict on private equity disclosure will be reached outside his chambers. This isn’t a reference to UC or a plaintiff’s attorney appealing the case to a higher

court, but rather to the larger issue of whether or not the private equity industry has been adversely affected by fund returns being posted on public LP Web sites and in newspapers and trade publications like Venture Capital Journal (see page 39 for the latest numbers from UTIMCO).

“What’s so interesting about all the attention given to the Sequoia and University of California [situations] is that the big picture on disclosure won’t be decided until at least the end of next year,” says a West Coast LP who participates in more than a dozen venture capital funds. “That’s when we’ll really know if disclosure was a good thing or bad thing for the industry. Until that time, it’s really just a bunch of guesswork.”


Disclosure of private equity returns first became a source of debate last fall, when the University of Texas Investment Management Co. (UTIMCO) heeded an attorney general’s directive to release all cash-in/cash-out and IRR data on what then was a portfolio of 124 venture capital and buyout funds. “I still think it was the right thing to do,” says Bob Boldt, the UTIMCO CEO who initially voiced reservations about his group’s ability to compete for new funds post-disclosure. “I just wish we could have gotten there without all the [political] messiness.”

Most general partners, however, felt that the messiness would be the end of disclosure rather than its means. After all, they argued, how would the venture-ignorant masses understand that IRRs on 1-year-old funds are barely more significant than pre-season football scores? The most strident opponents threatened to block UTIMCO and its disclosure-friendly followers from future fund offerings; while even moderate VCs worried that fund performance disclosure may represent the top of a slippery slope that ended with public access to portfolio company valuations and revenue projections.

But as time went by, most complaints seemed to fall by the wayside. Not only were most firms holding off on new fund-raising until 2004, but subsequent disclosure decisions by LP giants like the California Public Employees’ Retirement System (CalPERS) and the California State Teachers’ Retirement System (CalSTRS) suddenly calmed down everyone’s persecution complex. “Almost every VC has their dirty laundry out there, especially after CalPERS put all their IRRs online,” says one private university endowment manager. “Even Sequoia and Kleiner Perkins got bit by [the University of] Michigan, so you sound kind of stupid if you keep complaining that you’re being adversely affected by something that’s happened to everyone.”

Most backroom bluster was quickly channeled into concentrated ambivalence. Even Judge Richman noted in his ruling that “of the approximately 94 funds in which [UC] invests, less than one quarter have submitted declarations in support of [UC’s] opposition” to the release of IRRs.

Mark Heesen, president of the National Venture Capital Association (NVCA), argues that most VCs probably believed that an NVCA supporting brief would satisfy Judge Richman. “They assume that their voices are being heard through their trade association,” Heesen says. “VCs don’t spend their days looking at legal things because they are out investing in companies.” Heesen does acknowledge, however, that there are some investors who “have no issue with IRR information going out.”

One such firm is New Enterprise Associates (NEA), which has seen its performance figures released by both CalSTRS and the Connecticut State Treasurer’s Office. Nancy Dorman, a Baltimore-based administrative partner with NEA, says that her firm does not plan to specifically discriminate against public LPs in its recently launched fund-raising drive. “I think the positive thing to come out of all this disclosure issue is that all parties seem to agree on the importance of keeping individual portfolio company information confidential,” she says. “LPs like CalPERS and CalSTRS took very strong and articulate stands against letting the line slip below top-line data.”

Also holding its ground is the Washington State Investment Board, which reversed course after agreeing to send limited partnership agreements to Mark O’Hare, founder of upstart data provider Private Equity Intelligence Ltd. Rather than let O’Hare post the information – which included management fee terms and key-man provisions for several private equity shops – Washington State so far has persuaded O’Hare to refrain from posting the Washington documents on his firm’s for-profit Web site. The issue currently is in what one Washington official refers to as the “resolution stage.”

“If he had published that [LP agreement] information, it would have provided additional windows into private equity firms, beyond IRRs,” explains Tom Beaudoin, a Boston-based partner with law firm Testa, Hurwitz & Thibeault, which represents several of Washington state’s general partners. “There was a feeling that it was a confidential contract that would be exploited by competitors.”

To date, no other public LP is known to have intentionally released either LP agreements or underlying asset information. Bob Boldt of UTIMCO says such disclosures are off the table in his shop, and even the San Jose Mercury News – which is a co-plaintiff in the UC case and asked for underlying asset data in an earlier Open Records complaint against CalPERS – seems content with top-line info. “I am the former business editor here, and I believe that certain private company information should remain private,” explains David Satterfield, who recently was named managing editor of the Mercury News. “We’re just looking for IRRs.”

False Alarm?

So if the underlying asset concerns are allayed for all but the staunchest of worrywarts, is Judge Richman correct in suggesting that the entire disclosure debate is much ado about nothing?


While a recent disbursement report shows that VC deal volume has returned to its Q3 2002 pre-disclosure level (see news story, page 10), the bond between GPs and LPs has been severely weakened. Much of this is anecdotal, but there also is tangible evidence in the form of shrinking quarterly reports to limited partners. Whereas VCs once sent everything but the brand of a portfolio company’s kitchen sink to their LPs, disclosure-wary firms have begun employing a new category of “top-line data for underlying assets.”

“I think that the information we’re being given has become a hot-button issue,” says UTIMCO’s Boldt. “It’s not essential information that they’re holding back on, but more things like details about portfolio companies and about where the firm thinks its investments will be going in the future.”

And it’s not just public funds like UTIMCO that are getting less info. Private LPs also claim to be getting squeezed as VCs apparently have decided that it would be a violation of fiduciary responsibility to send out a sparse report to one set of investors (public LPs) and a more detailed report to another group (private LPs).

It’s likely that Judge Richman would consider such developments to be unfortunate, but not so much so that he would overturn his initial ruling (for the record, UC does not make the “reduced information sharing” argument in its motion for reconsideration). He’s looking for something meatier, as he implied when he memorably wrote that “none of the [UC Board of Regents’] the sky will fall’ concern has manifested.”

Wrong Turn

But Richman’s mistake is that he’s looking on the wrong horizon. The most pressing problems for public LPs like UC will not be uncovered by scanning the past 12 months worth of VC fund-raising acceptances and exclusions. If it were, then Richman might better have ruled that none of this disclosure hubbub matters because very few venture capital firms are even trying to raise new funds, save for occasional vehicles from firms like Sequoia (which took UC) and Three Arch Partners (which took CalPERS but excluded UC).

“There has been virtually no fund-raising in the past year, so it’s hard to tell what the [effects of disclosure] will be until more funds go out,” says the NVCA’s Heesen.

Indeed, Richman should have engaged in some calculated market forecasting. Most venture market participants agree that fund-raising will pick up in the waning months of 2003 and really gather a head of steam by mid-2004. Right now, the market only features a few well-known offerings from firms like NEA and Venrock Associates. Other players, like Charles River Ventures (CRV) and Accel Partners, are said to be gearing up for a run sometime next year. In almost every known case, the next generation of funds will be significantly smaller than the current crop. NEA, for example, has set out to raise $1 billion after having raised more than $2.3 billion in 2000. And both CRV and Accel are expected to seek well under $500 million each, despite having previously secured more than $1 billion apiece. Even Sequoia took a major cut by raising just $395 million, compared to the $695 million it snared three years ago – a move that contributed to the latest fund’s 10x oversubscription.

In each case, venture firms will have more return investors than they could possibly admit into next-generation offerings. Some financially challenged corporate and angel LPs will probably not ask to participate, but many of them will be supplanted by an emerging class of LPs from outside the United States. Moreover, many large institutional investors employ minimum allocation requirements that would prevent them from accepting pro rata stakes in funds that are 60% smaller than the last time around.

The way this math works is that top-tier firms will be forced to make exclusionary choices, and public disclosure will make for a convenient excuse. Nancy Dorman of NEA says that her firm does not plan to employ a disclosure litmus test to prospective LPs, but she adds that no fallback scenarios have been determined in case NEA’s new fund is oversubscribed.

The likely result is that public institutions like UC and UTIMCO will be shifted down the preference ladder into either startup funds, emerging manager funds or funds that have histories of middling returns. This is the very scenario that public LPs voiced concern about last year, and its reality is growing more likely with every downsized fund launched by a top-tier firm.

The only saving grace for public LPs could be that firms like Sequoia and NEA grew so fat and happy during the good old days of 1999 that they’ve gotten lazy and will unintentionally step aside for some younger guns. Given their history of strong returns, that’s a long shot, but it’s one that people like Bob Boldt are hanging their hats on. “It’s not always obvious who the top funds will be,” he says. “It’s just obvious who they have been. We’re in the business of finding funds that will be top-tier in the future.”

Summary Judgment

Boldt’s cautious optimism may sound like defeatism in disguise, but it illustrates how disclosure’s final legacy will be written long after either Judge Richman or his appellate overseers issue their UC rulings. The court case – and those that may follow – is a step along the way, but hardly the final destination.

Instead, it would be best to begin assessing the final verdict in about four years. That is when UTIMCO and the University of Michigan’s 2003 and 2004 vintage portfolios will begin to mature, and when quantitative evidence should emerge to support, or debunk, the claim that the top-tier funds of tomorrow are different than the top-tier funds of today.

If the former proves true, then the public interest will have been served twice by pro-disclosure rulings and decisions. But if the latter – and more likely – scenario emerges, disclosure advocates will be hard-pressed to explain how the balance of interests rests upon reduced payments to public pensioners.

Email: daniel.primack@thomson.com