Five more venture funds-including the first Israeli fund-confirmed in July that they would give back a combined $821 million in committed capital to their limited partners. The question now is whether there is room for more cuts.
The latest firms to cut are BRM Capital Management, Carlyle Europe Venture Partners, Viventures, Walden International and Worldview Technology Partners.
These latest reductions increase the total amount to be handed back to LPs to $4.2 billion by 15 different firms. They represent 17% of the 41 venture funds that raised $1 billion or more between 1997 and 2001. The year 2000 was the peak of fund-raising for mega funds, with 19 raised-and that’s the vintage year of six of the reduced megafunds.
Is there room for more cuts? Jesse Reyes, vice president of venture research firm Venture Economics (publisher of VCJ), says he doesn’t think so. “I don’t think the LPs will stand for much more because they have to figure out what do with all this money,” he says. “It means their allocations are all screwed up.”
The firms that want to cut their funds now will run into more resistance from LPs, especially those with overlapping investments in firms that have already cut their funds. “The LPs will probably say: Keep the money but reduce your fees to half of what we’re paying,'” Reyes says. And that’s going to lead to some battles between general partners and limiteds, he adds.
BRM has already felt the pressure. The firm, which invests in Israel, tried to appease its limiteds by offering to defer its full fee of 2.5% on its second fund and collect 2.15% for a period of time, but the LPs wouldn’t go for it, says Charlie Federman, managing director of BRM. The LPs wanted a fund reduction, and that’s just what they got on July 8, when BRM said it would return $100 million from its second fund, a $253 million emerging tech vehicle. “If you start getting a few of your LPs calling, you respond,” Federman says.
The fund cut leaves BRM’s second fund with almost $90 million to invest. It plans to allocate most of that amount to new investments in its bread-and-butter sectors: software and communications companies with strong ties to Israel.
Federman says he wouldn’t be surprised to see other Israeli funds follow suit. “I expect that other LPs will see that we are receptive and will put pressure on other Israel funds,” he says. One of those funds could be Benchmark Capital’s. When the Menlo Park, Calif.-based firm cut its European fund by 33% in May, one of its partners said the firm had no plans to reduce the $220 million Israeli fund it raised last year.
Israel’s high-tech market has been especially hard hit with a combination of economic and political instability. Valuations for startups are extremely low, lower than in the United States, and it is hard to attract new money to the region. While that makes it difficult to raise new funds focused on investing in Israel, it also means that the money already raised goes much further.
BRM counts two-dozen investors in its second fund, which was raised in mid-2000. They include Bezeq, IBM, Koor Industries, NTT Data and the Ofer Brothers. BRM GPs have more than a 50% stake in the fund. Federman would not reveal the names of the LPs that called for the fund cut.
In these tough economic times, BRM cannot afford to ignore the pressures its LPs are feeling, Federman says. “Our first priority is we have to show we can earn money for our investors,” he says. “We also have to show we are receptive to their needs.”
“Even with a 40% reduction we should be able to create a similar portfolio of companies for our [LPs],” Federman says. “And it still gives us sufficient capital to support the companies we have invested in with follow-on rounds as well.”
BRM, with a total of $250 million under management, has a portfolio that includes ActionBase, BackWeb (Nasdaq: BWEB), Check Point (Nasdaq: CHKP), Eventra, Kamoon, NetOnCourse, PeopleLink, Percite, ProSight, Schema and Whale Communications.
The firm’s recent investments include a Series A round in Passave, a broadband communications and semiconductor company, and a follow-on round for portfolio company ProSight.
Two days after BRM announced its cut, Carlyle Europe became the second European fund to reduce its size. It cut its first European fund by 11% to $642 million, citing a drop in valuations and a slower investment pace. What it didn’t say was that it was pressured by its LPs. Although last fall it was considering reducing the $724 million fund it raised in 2000, Carlyle was standing firm in mid-June, when company spokeswoman Daniela Zuin told VCJ sister publication Private Equity Week the firm would not cut its fund.
On top of the fund reduction, Carlyle Europe hired two new investment professionals, bringing its total to 18.
“We are still seeing good deals in the pipeline; we just don’t need as much to do them,” says a Carlyle spokesman who spoke on condition of anonymity. “Look around at some of the other firms that have cut their funds. We made the smallest cut and still have the largest fund in Europe.” The spokesperson does not expect more fund cuts.
Carlyle still expects the life of the fund to be roughly 10 years. So far, it has invested in about 20 companies including Bigvine.com, Omiris Networks Ltd. and Yazam.com.
The third European fund to reduce its size is Viventures. It cut its second fund on June 20 by 21% to $494 million from $633 million.
“The original aim of the fund was to invest between $20 million to $25 million over the life of a portfolio company, but everything has been scaled back by 20% or 25%,” explains Vivek Tandon, a U.K.-based principal with Viventures. “We had a choice to add investment managers or to put more burden on the ones we have, but we instead decided to keep the team intact and reduce the fund.”
Viventures II closed in early 2001 and is focused on telecommunications and Internet-related startups based in the United States, Europe and Asia. LPs include China Development Industrial Bank, Cisco Systems Inc., GE Capital Telecom, Goldman Sachs & Co., IBM Corp., Procter & Gamble Co., Qualcomm, Siemens Venture Capital, Singapore Power and VivendiNet.
Also on the international front, Walden International slashed its $1 billion Pacven Walden Ventures V fund to $750 million. “We raised the money at the tail end of the dot-com bubble, so we’ve had a significant reduction in deal flow,” says Gary Stroy, a managing director in the firm’s San Francisco office. “It’s pretty much the same story throughout the VC community.”
What is interesting about Walden, however, is that the firm already knew trouble was brewing when it originally closed the fund in early 2001. The vehicle had been marketed with a $750 million target but received about $1.5 billion worth of potential commitments. Walden figured $1 billion was a happy medium, but in May the partnership began discussions of how to maintain its investment strategy in a market that required less capital, Stroy says. There was some talk of extending the fund’s life, but the idea of fund reduction ultimately prevailed. Fund V remains dedicated to investing in both the United States and Asia.
Limited partners in the fund include AOL Time Warner Ventures, Commonfund Capital, CSFB, HarbourVest, Harvard Management Co., Goldman Sachs, MIT, Morgan Stanley, Robertson Stephens and Verizon.
Worldview Technology Partners
Back in the United States, Worldview Technology Partners has cut its $1 billion Fund IV by 25%. Rumors of such a move floated around for months, but the firm held off on an official announcement until LPs ratified the amendment in July.
“We wouldn’t want to be like Accel, where they proposed something and then had it thrown in their face,” Worldview General Partner Mike Orsak told PE Week in June in the firm’s first public comments on the matter. “This is a very LP-friendly agreement. … We did the spadework ahead of time to make sure they liked it.”
Worldview closed Fund IV at the end of 2000, after having gone out looking for $850 million. Since that time, the firm has invested barely 25% of its available capital.
Two Worldview LPs say they hoped for a slightly deeper cut, but Orsak says that the perception of widespread LP dissatisfaction has been manufactured by the media. “The press has been conveying that there are a bunch of angry LPs screaming at VCs [for fund cuts], but that’s not happening, except for isolated cases,” he says. “We were pleasantly surprised by how supportive and constructive our LPs have been. They thought long and hard about what we could do to improve our odds of success and they conveyed that to us.”
Limiteds in Worldview IV include the city and county of San Francisco, FLAG Venture Partners, Hewlett-Packard, Horsley Bridge, IBM, Invesco, Knightsbridge Advisors, Los Angeles County Employees’ Retirement Association, MacArthur Foundation, Salomon Smith Barney, Stanford University, Thomas Weisel Partners and the University of Michigan.
Rumors that VantagePoint Venture Partners and Menlo Ventures plan fund cuts are incorrect, sources close to the firms say.
Instead of cutting the size of its fund, VantagePoint is hoping to appease limited partners in its $1.6 billion Fund IV by loosening up on its management fees, according to two sources familiar with the situation. The San Bruno, Calif.-based firm told investors that it would defer the fees on half of the fund for the next 18 months, with the other half being tacked onto the back-end of the carried interest.
“I kind of wish that they would just reduce the size, but at least we’re not paying for such a large fund for a while, so I guess it works for me,” says one VantagePoint LP. “I think they may revisit this in another six to nine months.”
Menlo Ventures has no plans for cutting, either, says DuBose Montgomery, one of the firm’s managing directors. “We always told investors that we were going to invest for four to five years, and that is still what we’re going to do,” he says. “The only real change right now is that we’re having to hold on to a bit more capital for reserves.”