Funds In Brief –

Any firm that raised its inaugural fund in 1999 has to be considered a long shot when it sets out to raise a follow-on vehicle. Santa Monica, Calif.-based Palomar Ventures beat the odds, with the recent close of Palomar Ventures III, which was oversubscribed.

The $225 million fund had an initial goal of between $150 million and $200 million. Its previous fund, which closed in 2000, totaled $220 million. Palomar began marketing its third fund in March, expecting an October closing. It was oversubscribed in large part because of the returns from its inaugural $80 million fund, says General Partner Rick Smith.

One of the biggest returns came from Efficient Networks, a Dallas-based networking equipment manufacturer. After raising more than $40 million in VC, Efficient Networks launched a $60 million IPO in July 1999.

With the exception of the general partners, who invested 1% of the latest fund, Palomar Ventures III is funded entirely by institutional investors. Limited partners include CalPERS (California Public Employees’ Retirement System), Horsley Bridge, JP Morgan, Mellon Trust of New England (investing as a trustee of the Lucent Technologies Master Pension Trust), the National Railroad Retirement Investment Trust, and the University of California. Horsley Bridge and UC are new limited partners.

Smith says that the fee and carry structure remain unchanged from Palomar’s first two funds.

The firm will probably begin investing from the fund in the fourth quarter. Palomar Ventures usually invests between $2 million and $5 million per deal. The firm normally leads or co-leads investments in startup and early stage IT companies. Its focus has been on infrastructure software, networking telecom infrastructure, next-generation storage, security and wireless companies.

Palomar occasionally invests seed funding.

The firm recently co-led a $6 million Series A round for Datallegro, a provider of price/performance data warehouse appliances. Other recent deals include co-leading a $6 million Series A for data software provider Network Inference and co-leading Gluecode Software’s $5 million Series A round. -Matthew Sheahan

Mellon Stops New Investments

Mellon Financial Corp. (NYSE: MEL) is the latest financial institution to sour on the venture capital industry.

Mellon said in September that it would quit supporting its private equity group, Mellon Ventures, in making new investments. However, the Pittsburgh-based bank says it will continue to support its existing 130 portfolio companies and 50 general partnerships.

The decision follows in the path of other financial giants who have abandoned private equity before them. The last large investor to shed its private equity group was Morgan Stanley (NYSE: MWD), which announced that professionals from Morgan Stanley Capital Partners would become an independent firm. The new firm, Metalmark Capital, is based in New York and manages approximately $3.5 billion in Morgan Stanley private equity assets.

Mellon’s decision was made by the executive management team as part of an ongoing strategic review. Neither a company spokesman nor internal sources would comment on whether or not Mellon had considered raising a fund mostly backed by third-party money, similar to what J.P. Morgan Chase did two years ago. It is also unclear as to whether or not the Mellon Ventures team may try to spin out via a management buyout-like what recently occurred at Morgan Stanley Capital Partners.

Mellon Ventures was launched in 1996, and currently features approximately $1.4 billion in assets under management. It has offices in Pittsburgh, New York, Los Angeles and Atlanta. None of the Mellon Ventures team members have yet been laid off, although such moves are expected over the upcoming months or years.

Matthew Sheahan & Dan Primack

Benchmark Closes Second European Fund

Cracking into the European venture market has taken longer than Benchmark Capital expected, but the Silicon Valley venture firm is committed to succeeding. In mid-September, it held a first and final close on its second European fund, an oversubscribed $375 million vehicle that will target early stage technology companies.

Benchmark Europe II is smaller than the firm’s inaugural 2000 fund-a $750 million vehicle that later was trimmed to $500 million. But that is simply a reflection of a slower market, not the firm’s commitment. In fact, the European operation, which has its headquarters in London, plans to add one or two new investment partners over the next year or two, says Steve Spurlock, the operating partner of Benchmark Capital’s U.S. business.

The European team has one operating partner (Jerome Misso) and four investment partners: Johan Brenner, George Coelho, Mark Evans and Barry Maloney. It experienced a hiccup in late 2002 when Eric Archambeau, one of the founding general partners of the London-based fund, left to start angel investing in his native France. That opening was filled in January of this year by Brenner, founder and former chairman of TIME Vision.

How quickly the European fund brings on new partners depends solely on finding just the right person. “We’re not saying that we’ve got to have someone with X background from Y geography,” Spurlock says. “Given the team approach that we take, chemistry is everything.”

Benchmark could have easily raised more money for its second fund, in excess of $500 million, Spurlock says. But given the pace of deal making and its targeted investment cycle of 3 1/2 years, it chose not to raise a larger vehicle. It will invest about $10 million to $15 million per portfolio company, with first rounds ranging anywhere from $2 million to $10 million.

Because the LPs from Benchmark’s first European fund showed such strong interest-many of them asking for larger positions-it didn’t need to seek out any new LPs. Per Benchmark’s policy of not naming its LPs, Spurlock declined to say who invested in the new fund. He notes, however, that the LPs are primarily foundations and endowments, followed by funds-of-funds. The firm has historically avoided commitments from public LPs and those sorts of dollars were “not a meaningful component” of the new fund, Spurlock says.

Spurlock adds that there is significant overlap between the LPs in its European funds and those in its U.S. funds. LPs in its most recent U.S. fund include Horsley Bridge Partners and The Ford Foundation, according to Thomson Venture Economics (publisher of VCJ).

The European market has been slow, compared to the United States. While Benchmark’s fourth U.S. fund (raised in 2000) has seen five portfolio companies acquired, three go public and at least three more file to go public, its first European fund is still waiting for its first exit. None of that fund’s investments is even in registration.

Benchmark has found that “cultural issues were a bigger factor than we thought” and the various European markets are more dispersed than it realized, Spurlock says. The cultural issues generate obstacles, but you negotiate them successfully and that will give us a competitive advantage and enable us to generate superior returns,” he says.

To date, the first European fund has invested in about 25 companies. It will invest in a total of about 30 and will likely be fully invested by the fourth quarter. Among the companies it has invested in are Betfair, Kalido, Orchestria, Yoox.com, Alphyra and Openet Telecoms.

Benchmark’s areas of interest include enterprise software and services; communications and security; semiconductors; mobile computing; e commerce; and financial services. –Lawrence Aragon

3i Plans Asian Expansion

With the resignation of Martin Gagen as an executive director of 3i Group in late August, Allan Ferguson, who previously managed 3i’s Boston offices, has replaced Gagen as 3i’s U.S. CEO and country manager.

Ferguson, an 18-year veteran of 3i, set up the firm’s East Coast office in the 1980s. During the downturn in the early 1990s, 3i closed the office and Ferguson left for six years to work with Apax Partners. He returned to 3i when the firm decided to open its East Coast offices once again.

Gagen’s Asian responsibilities have shifted to Executive Director Chris Rowlands, who’s based in London, and who will now supervise 3i’s offices in Hong Kong and Singapore. Jamie Payton will continue to manage investments in the North Asian region of China, North Korea and Taiwan from Hong Kong, while Mark Thornton will still manage investments in Southern Asia, Singapore, Indonesia, Malaysia, Thailand and soon India from the firm’s office in Singapore.

Before leaving 3i, Gagen told VCJ in an exclusive interview that 3i’s emphasis across Asia has changed in recent years. The firm has downsized its Singapore offices, says Gagen, and the firm is expanding its efforts in China because “over the long-term, it is the only market in the region that will give a consistent deal flow for private equity investing.”

Gagen says that part of that expansion is the opening of a new Shanghai office during the next six to 12 months.

Gagen says that 3i will continue to employ its same strategy for deal making: invest in companies that are managed by professionals with experience outside of China and participate in syndicates with firms such as The Carlyle Group and Walden International.

Rowlands confirmed Gagen’s comments about China in a separate interview. He also said that the Southern Asia office is set for growth as 3i evaluates first entry into India from Singapore.

“We’re especially interested in consumer-facing businesses there, including financial services, leisure and retail opportunities, Rowlands said.

3i (which trades on the London Stock Exchange under the symbol III) was formed after World War II. It manages some $9 billion in assets and works in 14 countries, with headquarters in London. Individual country managers have control of the day-to-day operations and considerable autonomy. Most investment decisions are approved through a group investment committee, made up a subset of members of the firm’s executive committee. The firm invests in three areas: growth capital, venture capital and leveraged buyouts.

Six years ago, Gagen left the United Kingdom to re-open U.S. offices for his firm; first in Boston and later a second office in Silicon Valley, where until August Gagen served as the 3i CEO of the United States and of Asia. Gagen says he was long overdue to return to the London headquarters, but decided to remain in America.

“It has been an excellent time but after almost 20 years with 3i, and having done business in eight countries I have now settled in California for good.”

Gagen quit 3i to pursue a master’s degree in philosophy and history at Stanford University. 3i’s offices in Boston and Menlo Park, Calif., manage a portfolio of more than 80 companies valued at nearly $425 million. -Jerry Borrell

Galen Raises Fund for Med Tech

Marking a steady market for medical devices and pharmaceuticals, New York-based Galen Associates announced in August the closing of a $235 million fund. Galen Partners IV will invest in medical device companies, IT enabled service providers in the life sciences field and emerging pharmaceutical companies.

Galen initially sought to raise about $250 million, the amount of its last fund.

Limited partners in the new fund include GE Asset Management and Verizon. Past LPs in Galen funds include Chrysler Corp., Claude Worthington Benedum Foundation, DLJ Fund Investment Partners, New York Life Insurance Co. and St. Paul Venture Capital, according to Thomson Venture Economics (publisher of VCJ).

Galen typically invests between $5 million and $10 million per deal and puts between $10 million and $20 million into each portfolio company. It usually takes stakes worth between 25% and 50% of each company, but has sometimes found itself taking more than a 50% stake in a company.

The firm has made five investments from the new fund. It invested in Chamberlain Edmonds, which provides recovering receivable services for hospitals and patients; ONI, which provides MRI services; ENC, which provides software that allows hospitals to reduce malpractice insurance risks; Lumenos, a health care plan provider; and MedAssets, which provides a Web-based electronic commerce hub for trading medical equipment.

“The interest in health care has increased over the last six months to a year,” says Bruce Wesson, a managing partner with Galen. Indeed, pharmaceuticals and medical and health care investments took in $4.4 billion in private equity deals in the first half of this year, up from $1.3 billion for the same period last year, according to Thomson VE. –Matthew Sheahan

Israel Seed Fund Closes

Gemini Israel Funds, one of Israel’s oldest VC firms, closed on Gemini Israel IV in late August at $200 million. Like its predecessor funds, Gemini IV will focus on information technology, specifically enterprise software, communications and semiconductors.

Gemini’s 15 investment executives operate out Israel and Palo Alto, Calif.

Most of the Gemini IV investments will be made in seed- and early stage companies, for which Israel has become a breeding ground and where Gemini excels. Gemini has concentrated its efforts over the years on seed-stage companies, where Gemini’s hands-on expertise in company building has led to the funding of Verisity (which is now publicly traded) and Butterfly (acquired by Texas Instruments), among others.

The fund’s LPs include previous Gemini investors, such as MIT, Invesco, California Public Employees’ Retirement System and Grove Street Advisors. They were joined by Morgan Stanley, Wilshire Associates, Spur Capital, Offit Hall Capital Management and Horsley Bridge.

In addition, Paul Gompers, professor of business administration at the Harvard University Business School, will join Gemini’s advisory board.

“We are pleased with the varied make-up of Gemini’s fourth fund investor base, particularly the interest from European investors, some of whom have never invested in Israel before,” says Yossi Sela, a Gemini co-founder and managing partner. “The awakening of European interest in Israel is a trend that will positively impact the entire Israeli venture capital industry.”

Gemini expected to begin making investments from the new fund in September.

-Alastair Goldfisher

Illinois Launches State Fund

To stop the flow of technology and brainpower from leaving the Prairie State, Illinois has launched a $50 million technology development fund.

The fund is expected to have a three-year life and will invest in private equity funds that are based in Illinois and that invest in the state.

Robert Morgan, director of private equity at Northern Trust Global Advisors, which will serve as an outside advisor to the fund, says that he expects between 60% and 75% of the fun to be invested in venture capital funds. He says that the $50 million fund will likely invest in between 15 and 20 funds.

Morgan acknowledges that advising a state-backed venture fund is a delicate balancing act of generating a return on a fund, as well as accomplishing the fund’s mission of supporting business in the state.

“The problem is it’s tough to find an above-median private equity firm that does all its investments in Illinois,” Morgan says. Morgan plans to present the board with a strategy that will invest not only in firms that do the majority of their investment in Illinois, but also firms with appealing track records that may have offices in Illinois or links to other nearby states.

Illinois State Treasurer Judy Baar Topinka will have the final say in the investments that are made. She will be assisted by an advisory board that includes Ellen Carnahan, a managing director with William Blair Capital Partners; Keith Crandell, managing director with ARCH Venture Partners; Robert Finkel, managing partner of Prism Capital; and Carl Thoma, a managing partner with Thoma Cressey Equity Partners.

The technology development fund may not be the only state venture fund in the game in Illinois. Gov. Rod Blagojevich has proposed setting up a $200 million venture fund to invest directly in Illinois startups. A bill establishing the fund passed the Illinois State Senate this past spring but has been held up in the State Assembly, which expects to continue work on it this fall.

In the past few years, individual state governments have sought to bolster their homegrown technology markets and spur job growth through state venture funds. There is evidence to suggest this not all wishful thinking or election year pandering.

A study sponsored by the National Venture Capital Association, and conducted by economic forecasting firm Global Insight, shows that companies receiving venture backing outperformed those that did not. New venture funds with state government backing have recently sprouted in Connecticut, Hawaii, Iowa, Ohio, Oklahoma and Utah.

-Matthew Sheahan