NEW YORK In Venture Economics’ July release on venture capital returns, early-stage venture firms outpaced other forms of private equity over every legitimate period. However, many different firms label themselves early-stage shops, even one managing more than $1 billion which said it invests as low as $50,000 in its deals.
“There’s no way in God’s Earth, they would ever write a $50,000 check,” said Ed Goodman, partner of Milestone Venture Partners. With 27 years experience in the industry, Goodman and four of his New York-based peers managing less than $30 million discussed the differences in their business versus the mammoths of the venture world.
To start, Milestone and its peer funds only count two groups as investors: individuals and other VC funds (in one case a hedge fund).
No institutions have invested in Goodman’s efforts at Milestone, which held a $10 million first close on its second fund in June. Goodman said the firm’s strategy executes well up to about $75 million, and he is considering applying for an SBIC license to get the leverage to take him there.
Goodman said the risk profile of a small, new partnership investing in early-stage companies is too high for most institutions. Individuals, he said, filter their investments differently, deciding intuitively without running risk analysis on spreadsheets.
About 60 individuals invested between $50,000 and $1 million in Pennell Venture Partners LLC’s $20 million second fund. General Partner Thomas Pennell calls his $3.5 million first fund, the world’s smallest venture fund, adding, “We had to get into the business somehow.”
These guys lobby for every $50,000 check they can get, filter through piles of deals looking for the two or three they will support this year, and they scrap it out for the right to do it again tomorrow. This area of the business is a strange mix of funding the entrepreneur and being the entrepreneur.
The partners at a $1 billion fund theoretically make $20 million in management fees every January when they turn on the lights for the first time. One VC in this article estimated he would take home a salary between $10,000 and $100,000 this year.
Most of these funds get into deals for less than $1 million the first time through, possibly beefing it up through syndication. They said they paid particular attention to the ability of their co-investors to join them in an unexpected inside round.
“The biggest challenge for early-stage venture capitalists our size is the financing risk going forward,” said Eric Vincent, partner at StartingPoint Venture Partners LLC, which has $26 million under management. His peers echoed his concern over running out of capital to support their companies.
Steve Brotman, managing director at Silicon Alley Venture Partners which manages $16 million said, “If you’re $7 million short [of profitability] a bigger fund can write that check tomorrow. [Small funds] can’t cover up mistakes with cash.”
In tough times, they also said syndication adds more “eyeballs around the table” and deepens the operating experience upon which the management team can depend. Even in the best of times, a syndicate creates a bigger Rolodex, as one VC said, for the management team.
Paul Lisiak, managing director of Metropolitan Venture Partners which is managing $20 million and raising an additional $50 million, said he likes to bring larger players into the deal and give them a taste for the company with later rounds in mind. He also takes deals to established firms in pursuit of a little quid pro quo in the future.
Lisiak said he enjoys the culture of the venture business at this level more than he likes the investment-banking feel that prevails at some larger firms. “It’s the difference between consulting and being everything from an executive to a psychiatrist at times.”
In the true spirit of the entrepreneurial atmosphere and low support resources, one VC called a time-out in the middle of the conversation to view and bid for a Manhattan apartment.
“Ultimately [with a large fund], you’re out of the venture business and into the stock-picking business,” said Pennell. “You may not give a damn, because if you make a 20% return with a billion-dollar fund, you do a lot better than me with a 50% return.”
Brotman said, “We’re what venture investing was 20 years ago.” However, he looks up to his LPs and other larger funds with envy. Lisiak said the economics of VC work in favor of expansion, and he hoped to scale to about $300 million to $500 million.
Goodman, Pennell and Vincent all thought a series of $100 million funds managed by a handful of partners was the ideal way to run a venture firm.
“Everybody says [they will stay small], but they do otherwise,” Goodman said. Pennell also predicted he might eat his words.
With a resume full of winners, Goodman said venture investors could make money without getting greedy. The venture business is a custom-suit business not a mass-retail business, and one big hit will guarantee success for a firm of any size.
As further evidence of the injustices of life at a small VC fund, our friend who made a bid for the apartment was cheated out of it by the broker just like any other Manhattanite has been.