Heading Down the Aisle?

Unable to raise new funds, a growing number of dot-com era venture firms are merging in hopes of improving their odds of surviving.

“The discussions haven’t hit the media yet, but what other alternative do they have?” asks Dick Strayer, CEO of Strayer Consulting Group, an organizational development firm that counts 20 venture firms on its client roster. “Either you drop out and do something else, or you think about who you can partner with—where some of your people will have a good home and who will give you a better chance of coming out of this in two years.”

Struggling VCs shouldn’t have too much trouble finding willing merger candidates. More than 200 venture firms that raised funds nine years ago haven’t been able to raise follow-on vehicles, according to Thomson Reuters (publisher of VCJ).

Strayer says he knows of “at least four or five firms” that hope to get through the downturn by joining forces. And he expects more to come.

Only a handful of venture firms have come together since the tech bubble burst. Judging by the spotty track record of fund-raising for the combined firms, merging is the easy part of the equation.

Of five merged firms tracked by VCJ, just two have had success in raising new funds since they tied the knot:

• Rustic Canyon Ventures, which merged with Staenberg Venture Partners in 2003, went on to raise two new funds in 2005 and 2007 for a combined $313 million.

It’s helpful to have someone who can ask questions behind the scenes and find out if a fit is really there. Because once you merge, it’s hard to go back.”

Jon Staenberg

• And Onset Ventures, which merged with Diamondhead Ventures in late 2007, closed on $183 million of a planned $250 million fund last December.

Three other merged firms haven’t been as lucky:

• Artemis Ventures and Novus Ventures merged in July 2002, but the resulting firm, known as Novus Ventures, hasn’t raised a new fund since then, according to Thomson Reuters. Also, Thomson Reuters shows that Novus hasn’t made an investment since November 2007. Managing General Partner Daniel Tompkins didn’t respond to an email seeking an interview.

• Osprey Ventures and GKM Ventures formed a “comprehensive investment alliance” in 2007, but neither has raised a new fund since then. Osprey, which raised an inaugural fund of $92 million in 2000, made its most recent investment in September 2007, according to Thomson Reuters. For its part, GKM raised $50 million in 2001 and another $50 million the following year, but it hasn’t raised a fund since then, according to Thomson Reuters. It must have some capital, since it participated in February with eight other venture firms in a deal for mobile messaging company Visto Corp. David Stastny, who is listed as managing director for both Osprey and GKM, didn’t respond to an email seeking an interview.

• Finally, ComVentures merged with Velocity Investment Group in December 2007, but the merged firm, known as Velocity Interactive Group, has yet to close on a new fund. ComVentures most recently raised $300 million for a sixth fund in 2005.

Those who’ve been through VC firm mergers say one of the most important questions to ask is whether the firms in question have similar cultures. “When you have a limited number of people working together, it’s like a marriage, so you want to make sure you match up well and that you bring complementary skill sets to each other,” says Jon Staenberg, an advisory partner for Rustic Canyon. Even though he stopped investing on behalf of the firm last year, Staenberg considers his firm’s merger with Rustic Canyon to have been “very helpful” to both firms.

Developing the necessary rapport isn’t an overnight process, no matter how well the GPs know one another at the outset. For example, although two of Rustic Canyon’s partners were investors in Staenberg Venture Partners, the parties spent six months getting better acquainted after merger talks began, including over numerous dinners and in meetings with the CEOs of both funds’ portfolio companies.

You have to want to put the good of the firm in front of everything else, and to trust the people you’re doing this with.”

Ross Levinsohn

Diamondhead and Onset Ventures contemplated a union for nine months, despite longstanding friendships and a history of co-investments between several of the partners.

Ross Levinsohn, a partner with Velocity, says a merger won’t work “if some of the partners are going to harp on petty stuff, like who is making more money or who is flying business class when you are flying coach. You have to want to put the good of the firm in front of everything else, and to trust the people you’re doing this with.”

You should also be prepared for some of the people involved in the merger to be unhappy. In joining forces with Velocity, ComVentures left two of its partners out in the cold: Jeb Miller and Michael Rolnick.

“It wasn’t a pleasant thing to consider, but sometimes you just have to rip the bandage off and make the change,” Roland Van der Meer, founding partner of ComVentures and now a partner with Velocity, said at the time. “This was about whether or not there would still be a firm left to turn around.”

An even bigger concern for both sides is whether one plus one equals three. While limited partners might be interested in harmonious relationships, they’re far more concerned with results. After all, the whole idea is to raise another fund.

For his part, Levinsohn says that he and Jonathan Miller, the two partners of the original Velocity, brought “rich, deep operating and digital media experience, while ComVentures brought their collective experience as communications investors.”

Onset’s David Lane, who co-founded IT-focused Diamondhead, says that Onset’s health care team was one factor that drew the firms together.

What isn’t part of a negotiation can saddle the new partnership afterward. And you want to know going in: Is this a marriage that’s going to work?”

Dick Strayer

As for Staenberg and Rustic Canyon, Staenberg says: “I had a tagline of connecting San Francisco and Seattle. They had offices in L.A. and Redwood Shores. It made sense for us to come together to cover the West Coast.”

There are also plenty of logistics to consider. Who breaks whose lease? Do you combine back offices? “Logistics can be tough,” notes Staenberg, who says that among other things, “we underestimated the coordination involved in having a third office. Even though it was just one more, it was a big jump from two to three.”

Levinsohn says logistics was a tough issue for Velocity, too. He is based in Santa Monica, Calif., while Miller is in New York, Keyur Patel (originally with ComVentures) spends most of his time in India, and Van der Meer and David Britts (originally with ComVentures) are in Palo Alto, Calif.

“We had to commit to spending the time to travel to be together as many weeks of the month as possible,” says Levinsohn, adding that he and his partners still rotate partner meetings each month between Los Angeles, Palo Alto and New York. “That might ease up now that we really know each other, but we had to make that commitment in the first year and a half.”

GPs are more reluctant to discuss the economics that must be hashed out for two venture firms to merge successfully. While Lane says the carry discussion for Onset and Diamondhead was short because the firms were structured almost identically, that’s an exception, not the rule.

As Staenberg points out, the differing ages of the combining firms alone can complicate matters. “If you’re talking about merging with a seventh or eighth fund, that’s different than a second fund,” he says. “You need to think about how long the team has worked together, and whether this will be a 50/50 relationship.”

It’s one reason for bringing in a third party like Strayer, who works with teams to find common ground. “There are so many considerations—from metrics to promotion criteria to due diligence to voting dynamics,” Strayer says. “What isn’t part of a negotiation can saddle the new partnership afterward. And you want to know going in: Is this a marriage that’s going to work?”

“An outside mediator is a very good idea because [in discussing a merger], everyone puts their best face forward,” says Staenberg. “It’s helpful to have someone who can ask questions behind the scenes and find out if a fit is really there. Because once you merge, it’s hard to go back.”

Additional reporting by Lawrence Aragon