It’s Easy Come, Easy Go for VSP Capital –

Before handing over your money to a venture firm in the midst of fund-raising, consider the case of Joanna Rees-Gallanter and the firm that she founded, VSP Capital. Its is a tale that underscores the importance of general partnerships being just that-a place where the power of the business is derived from the team.

After a relatively quick close in March for its third fund (see “Third Time Around Easy for VSP Capital,” VCJ, May 2005), VSP just as quickly saw its limited partners pull the plug on the fund two months later. The firm’s LPs and GPs (past and present) declined to talk about fund III’s demise. But sources close to the San Francisco-based firm blame friction between firm founder Rees-Gallanter and three of VSP’s five general partners. That friction, they say, resulted in the termination of one GP and two others tendering their resignations.

So it was that in a span of just two months that a firm went from five investment pros, a new $185 million fund and a rosy outlook to a firm with two investors managing what’s left of an old fund and facing an uncertain future.

Rumors of discord in VSP’s partnership first surfaced last November, when General Partner Tony Conrad, legally a “key man” in VSP’s second and third funds, abruptly left the firm. Five months after Conrad’s departure came the resignation of GP Vince Vannelli, and six weeks after that the resignation of GP Matt Crisp, a key man in VSP’s third fund. Not only did Crisp’s departure mean that the firm was now down to two GPs, but in conjunction with the earlier exit of Conrad, his departure triggered the key-man clause in VSP’s LP agreement, allowing the LPs to vote on whether the third fund should continue.

In late May, VSP’s LP advisory board voted unanimously to recommend to all of the firm’s 14 limited partners that the firm’s third fund be discontinued. Since the six LPs on the advisory board collectively committed slightly more than three-quarters of fund III, they didn’t actually need permission from any other LPs. The members of the advisory board are Adams Street Partners, Duke Management Co., Horsley Bridge Partners, Parish Capital, TD Capital and the University of California.

“Most agreements do allow the LPs to shut down the firm if they decide that it’s in their best interest to do so,” says Carl Metzger, a lawyer in the litigation group of Goodwin Procter. “They don’t typically need a reason, in other words. What they do need, typically, is a two-thirds vote, or a super majority [of LPs wanting to shut down the fund] of 70 to 80 percent.”

Metzger was not involved in the VSP case and was speaking generally about dissolutions. He said that in similar cases that he has seen, investors stop the possibility of any future capital calls and that a wind-down period is usually negotiated with a fund’s managers, who continue to oversee investments that they have made, but who see reduced terms in compensation to do so.

Warning Sign

VCJ’s sister publication, Private Equity Week, first reported that trouble was afoot at VSP in mid-May, noting that Vannelli had resigned and that limited partner Duke had contacted investors about selling its stake in fund III. Rees-Gallanter was angry about the report and asked for a retraction. In a voicemail to a reporter, she said: “I’m shocked. It’s absolutely inaccurate. Vince has absolutely not submitted his resignation. He’s working hard and is very much here, so I don’t know where that came from, and I just think this whole thing is garbage.”

In a subsequent interview, Rees-Gallanter said she had “talked to our contact [at Duke] and they said they’re supportive of their investment.” She also said that she would have Vannelli send an email stating that he had not resigned from the firm and had no plans to. The email never arrived. When PE Week sought further comment, Tom Phillips, a sales and marketing expert affiliated with VSP, sent an email that read in part: “Our policy at VSP Capital is not to comment on management matters of the firm as it concerns gossip and innuendo.”

Rees-Gallanter finally conceded in an email to VCJ on June 7 that fund III was kaput. That email states: “In light of the triggering of the key man provision, the senior management of VSP Capital has recommended to the firm’s limited partner advisory board to discontinue further investments in VSP III and concentrate resources on the firm’s existing portfolio companies. As fiduciaries, we feel this is the most responsible and conservative course of action with the best interests of our LPs and portfolio companies in mind. The firm will also take all necessary and appropriate actions to assure that all former partners have adhered to their fiduciary responsibilities, as well.”

Rees-Gallanter declined to comment further, as did John Hamm, who joined the firm as a GP last fall. He and Rees Gallanter are the only investors left at the firm. Partner Dana Settle, who left Mayfield to join the firm late last year, resigned in early June.

VSP made just three investments from fund III. Those investments, according to a source close to the firm, are Evil Twin Studios, a San Francisco-based character animation startup; Truveo, a Burlingame, Calif.-based startup focusing on targeted data mining; and Umbria Communications, a Boulder, Colo.-based startup that provides market research by collecting and analyzing postings from millions of weblogs. Officials for Evil Twin and Truveo could not be reached for comment and Umbria’s CEO had no comment.

From the Start

Rees-Gallanter founded VSP as Venture Strategy Partners back in 1996 to provide strategy consulting to startups. It took her a couple of years to raise her first fund, a $25 million vehicle that held a final close in 1999. Despite her lack of experience in VC, she did well enough to raise a second fund of $195 million in 2000.

Since its beginning, VSP has made 47 investments. Of those, 21 remain private and 14 are out of business. Another 11 VSP portfolio companies have been acquired or merged. Among its hits:

  • Post Communications, a marketing company, which was bought by Netcentive for $140 million in stock in 2000. It had raised $24.8 million from several VCs, including VSP.
  • Oddpost, a Web mail service bought by Yahoo in July 2004 for an undisclosed amount. (Rees-Gallanter said in an earlier interview that VSP made 5x on the $2 million that it invested in Oddpost.)
  • ZipRealty, a residential real estate brokerage that went public in 2004. At the time of the IPO VSP owned 1.6 million shares of the stock, which debuted at $13.

Sources say that the next step for VSP’s limited partners is to decide what to do, if anything, with the firm’s second fund, which has about $55 million left for follow-on investments. Fund II has invested in 28 companies, including two that have gone out of business and eight that have been acquired. Among the companies that remain in fund II are AccountNow Inc., an online banking service based in San Ramon, Calif.; Danger Inc., a maker of wireless messaging devices based in Palo Alto, Calif.; and E4X Inc., a foreign exchange hedging service in New York.

It could take months for LPs to decide what to do with fund II. Since Rees-Gallanter and Hamm have made it clear that they want to continue to manage fund II, the LPs could choose to leave it in their hands, according to a source. Another option: Sell part or the entire portfolio on the secondary market.

Whether Rees-Gallanter, who Forbes once dubbed the “Alley Cat,” will land on her feet again remains to be seen.