POPALO ALTO, Calif. – Feeling overly dependent on mezzanine funds and private placements to feed their expansion-stage portfolio companies, four venture firms have banded together to launch a $1 billion-targeted fund to support businesses in the six to 18 months leading up to their initial public offerings.
Accel Partners, Brentwood Venture Capital, Oak Investment Partners and Worldview Technology Partners formed MertiTech Capital and quietly began fund raising in March.
Former NationsBanc Montgomery Securities investment banker Paul Madera was hired as the firm’s first managing director to oversee the fund, and a second, unnamed managing director was close to coming on board at press time.
The pair will review portfolio companies from the four sponsoring firms, conduct due diligence and propose investments of $15 million to $30 million to a four-member investment committee that will make final decisions.
The investment committee is composed of one member from each firm: Jim Breyer from Accel, John Walecka from Brentwood, Bandel Carano from Oak and James Wei from Worldview.
MeriTech will first turn to limited partners from its sponsoring firms to raise capital for the new fund. The vehicle initially had been slated for a $750 million target, but the goal was quickly boosted to $1 billion because of enthusiastic investor response, Mr. Madera said. Mr. Breyer expected a first close in April and a second in May.
Most of the L.P.s contacted had only recently heard about MeriTech and had not yet made any investment decisions.
Accel’s team had discussed creating its own proprietary mezzanine fund but decided on a cooperative model because it included advantages such as checks and balances imposed by outside fund managers and access to other high-quality deals from other firms, Mr. Breyer said. He also was concerned that a later-stage Accel fund might detract from the firm’s focus on early-stage information-technology companies.
“I wanted to ensure that there was as little distraction as possible on the part of the partnership relative to what our core charter is,” he said, adding that the portfolios of the four firms were complementary. Oak has a practice in later-stage companies, buyouts and consolidations, while Accel and Brentwood focus on early-stage Internet and communications companies. Worldview, meanwhile, specializes in helping companies expand their businesses to Asia.
Most MeriTech backers will invest some $30 million to $50 million each, and a couple of $100 million investors also are expected, Mr. Breyer said. The fund features an 80%/20% carried interest split, and the management fee had not been set by press time.
Adapting to the Times
About a decade ago, as many as a half-dozen venture firms would band together to fund a company until it could brave the public markets. Venture firms today, however, find it increasingly difficult to keep up with financing needs as software has become more complicated and engineering talent more expensive. Today’s growing technology concerns also need more capital to prove their developments before they can hold an IPO, Mr. Madera explained.
As a result, late-stage private placements and late-stage funds have stepped in to fill the vacuum. But on the negative side, getting money from those sources can be time consuming and highly subject to market fluctuations when it comes to valuations. Further, entrepreneurs considering private placements are forced to disclose confidential information to numerous potential buyers before securing capital.
“This fund is intended to be a fast and very fair way of financing late-state companies that won’t have to put the time and unpredictability into seeking financing and … they can do it very confidentially,” Mr. Madera said.
Prior to joining MeriTech, Mr. Madera spent five years as NationsBanc Montgomery’s head of private placement, and before that, he worked for Morgan Stanley. The sponsoring firms will get a cut of the carried interest to ensure that MeriTech will remain a priority for them, Mr. Madera explained.
The six-year fund will have a three-year investment phase, and Mr. Madera expects to begin making investments in the late spring.
MeriTech will back about 50 companies, said Brentwood’s Mr. Walecka, who estimated that his involvement with the new vehicle would ultimately equal the amount of work generated by sitting on the boards of two companies.
Mr. Walecka thought it was a “very clever idea” when Messrs. Carano and Breyer approached him about creating a novel fund. His colleagues at Brentwood also were intrigued by the idea.
Worldview was similarly pleased with the plan, although Mr. Wei said his firm would leave “a smaller footprint than the three other firms.” Worldview plans to contribute deal flow, assist MeriTech with due diligence and help companies expand business to the Far East.
Nevertheless, Mr. Wei does not expect Worldview portfolio companies to receive automatic funding from MeriTech, and he has made that clear to company managers. “It’s not a done deal by any means, and I wouldn’t represent that to entrepreneurs.”
No Arm Twisting
Mr. Breyer noted that while the four firms could introduce companies to the MeriTech managing directors, it would be up to them to decide whether to bring a company before the investment committee with a funding recommendation. The Accel managing partner did not expect his colleagues to feel pressured into approving each other’s deals.
Better Than a Solo Fund
“I would hope that if one of the investment committee representatives or the management team were uncomfortable with a deal I would propose, they would come right back to me and explain why,” he said.
The partners determined $750 million was the “minimum dollar amount that would allow this fund to invest in the most attractive, high-momentum, expansion-stage projects,” Mr. Breyer said. The target grew to $1 billion, however, to accommodate expected investor interest.
The fund’s leadership does not think investors who have backed MeriTech’s sponsors will feel they are putting too many eggs into one basket if they invest in the new vehicle. Rather, as Mr. Breyer points out, MeriTech will be a chance for L.P.s whose commitments to the four funds were pared down to now compensate for some of the reductions in their commitments.
Mr. Madera added that MeriTech was a great way for L.P.s to invest across several funds. Returns, however, should not be expected to meet those of early-stage vehicles. “In this fund, we would expect to have lower returns per investment but ultimately more consistent returns across the portfolio, so it’s a different risk-reward profile than the underlying funds,” he said.
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