SEATTLE – Frazier & Co. in late January wrapped its fourth fund, Frazier HealthCare III, on almost $220 million, more than double the firm’s last vehicle and about $60 million more than its goal.
Despite exceeding its fund target, the strictly health care-focused firm does not expect to have difficulty putting the extra capital to work. Frazier engages in traditional venture deals but also employs what general partners call the firm’s “corporate strategy,” which involves backing more mature companies such as those with $10 million to $15 million in revenue and a proven track record, explained General Partner Nadar Naini. In many cases, corporate-model companies are profitable and seek growth capital.
Frazier looks for candidates with strong management teams that operate in consolidating markets, and the venture firm considers initiating roll-ups. Frazier’s corporate strategy also involves spinouts and taking fallen angel public companies private, although that requires persuading shareholders to sell out at a loss. The group has closed about eight deals using its corporate strategy, Mr. Naini estimated.
Bigger Deals Planned
Frazier HealthCare II’s traditional venture deals averaged $4 million each, and in Frazier III that figure will grow to $5 million, said General Partner Alan Frazier. Corporate strategy investments also will increase to $10 million to $15 million from about $8.5 million.
The new vehicle probably will back some 25 companies, including biopharmaceuticals, pharmaceutical service companies, medical devices and traditional health-care services, Mr. Frazier said.
General partners Fred Silverstein, Bob Overell, Jon Gilbert and Messrs. Naini and Frazier will manage Frazier HealthCare III. Dr. Overell was promoted to general partner halfway through the investing of Frazier II, and the firm plans to add associates but not general partners, Mr. Frazier said.
Frazier boosted the target size of its new vehicle because the firm found it had too little capital in previous vehicles to take as large a share in some portfolio companies as Frazier would have liked; instead, the firm was forced to bring in other investors, Mr. Naini explained.
Frazier attracted most of its existing limited partners to the new fund, with the exception of three – SBC Warburg Inc., a division of Swiss Bank, and the pensions of General Electric and U.S. West – all of which are backing away from new venture investments, Mr. Frazier said.
Raymond Yee, executive director of the equities operation that had been known as SBC Warburg Inc., confirmed that the group had ceased making venture investments in light of the Swiss Bank’s merger with Union Bank of Switzerland. Nevertheless, Mr. Yee personally invested in the new Frazier fund because “there’s no question that they have defined the turf and have good capabilities in it,” he said. General Electric declined comment, and U.S. West did not return calls.
Competing with IT
Frazier faced the challenge of raising its health care-only fund as high returns were drawing increasing amounts of capital into information-technology funds and as the public market performance of smaller medical device and biotechnology companies continued to lag.
“We were somewhat nervous about going into the marketing with health care being so tough,” Mr. Frazier acknowledged. Frazier’s success stemmed from the firm’s unusual two-part investment strategy; a developing trend among limited partners to gravitate toward sector-specific funds rather than diversified offerings; and a desire by long-term venture capital investors to maintain an interest in health-care funds to leverage their stakes in IT vehicles.
“L.P.s demonstrated to me a very mature view on sector allocation, and I expected them all to be jumping totally into IT,” Mr. Frazier said.
In fact, returning L.P.s averaged commitments three times what they put into Fund II, Mr. Frazier noted. Although the median institutional investment to Frazier III stands at $7.5 million, the Washington State Investment Board is the firm’s largest backer, putting up $40 million for the new vehicle, Mr. Frazier said.
Other returning L.P.s include Northwestern Mutual Life Insurance Co., the Pritzker family and the University of Washington endowment. New backers include the General Motors Investment Management Corp., Pathway Capital Management L.L.C., Delta Air Lines Benefit Trust, Pennsylvania State Employes’ Retirement System, Frank Russell Capital Inc. (on behalf of Anlagestiftung Asea Brown Boveri), Mitsui & Co. (USA) Inc., Tucker Anthony Private Equity Group, Vulcan Ventures Inc. and Matthew G. Norton Co.
The bulk of capital in the new fund came from institutional and state funds, which put up 41% and 39%, respectively. Twelve percent came from family offices and 4% from individuals, while 3% came from endowments and the remaining 1% from the general partner.
Terry Blaney of Delta’s pension had invested in Frazier’s earlier funds when he worked for the state of Washington, and he has backed the latest Frazier vehicle. “Alan (Frazier) has a differentiated strategy he’s proven he can implement, and he’s now a real player in this business rather than a co-investor, which is how he started out,” Mr. Blaney observed.
Frazier HealthCare II, closed in 1996 on $90 million, has completed making new investments, Mr. Frazier said. Frazier HealthCare Investments L.P., a 1996 $36 million vehicle, and Frazier Portfolio Fund, a $5 million 1991 fund, are fully invested. Frazier’s funds have posted returns of more than 20%, Mr. Frazier said. The first two funds are almost fully realized.
Frazier has two partners who work almost exclusively on health-care service deals and three partners who work in the health-care product area. Mr. Naini estimates about 50% of the new vehicle will be invested in health-care services.
M&A Exit of Choice
Frazier tends to lead its portfolio companies toward an M&A exit, which requires that they accept lower valuations and curb expenses to be attractive to potential buyers. Frazier will consider the public market but prefers sales, given the recent performance of the small-cap medical sector. Often, the firm backs second- or third-time entrepreneurs who understand and favor this exit strategy. First-timers, however, are more likely to want an IPO, Mr. Frazier explained.
“We’re just very, very determined that our management teams follow this strategy,” Mr. Frazier emphasized.
In addition to targeting growth-stage private companies, Frazier also looks carefully at spinouts for corporate-strategy investments, Dr. Silverstein said. The appeal of spinouts include the likelihood that the larger parent has the expertise and resources to have secured intellectual property rights, composed good licensing contracts and pursued quality regulatory advice.