Reid Dennis is almost ready to quit. The 78-year-old is a part-time general partner in Institutional Venture Partners’ 10th fund and he expects to be a part-time GP in its 11th. But after that, he says, he’ll pack it in. “I’ve been in the business for well over 50 years,” he says. “That’s long enough. The senior partners have got to get out of the way of the younger people or else the younger people are going to go somewhere else. We had that happen.”
Dennis’ firm broke apart five years ago with partners moving on to found Redpoint Ventures and Versant Ventures. Partners he thought would be around to see IVP into the future are no longer there. He blames the Internet bubble-not a lack of succession planning-for the breakup of the firm. “There were an awful lot of confused people in the bull market who thought they were smart,” Dennis says.
The issue of succession planning has moved to the front burner for many firms. Among those that have undergone roster changes are Battery Ventures, Benchmark Capital, Charles River Ventures, Kleiner Perkins Caufield & Byers, Mayfield, New Enterprise Associates (NEA), Sevin Rosen Funds, Spectrum Equity Investors and Venrock Associates.
“This is an industry that’s still going
through its first generation of senior partners,” says Dave Welsh, a general partner with San Francisco’s Partech International. “It started 25 years ago and the guys are getting to the age now where it’s time to retire. I don’t think it’s ever really hit the industry as hard as it is now.”
And that raises all sorts of thorny questions. As veterans and marquee partners leave the industry, are the partners they leave behind prepared to fill their shoes? Have enough firms put succession plans in place? Will a succession plan even make a difference?
What’s at Stake
Paul Kedrosky, a business professor at the University of California in San Diego, says succession planning is even more important now because the disruption caused by the Internet boom and bust delayed the flow of mentoring and succession that should normally take place in such an apprenticeship industry. “While you might have expected that the downturn may have changed a lot of that, it hasn’t changed much at all,” he says. “In fact, despite the urgencies, funds have become leaner so it’s become less obvious that they were only leaving behind the people who demonstrated an ability to raise money and close deals.”
VCs confess that, for the most part, they haven’t made the time to put formal succession plans in place. The post-Internet bubble shakeout and other accumulated market woes have kept succession planning on the back burner. “When you go from a $1 billion fund to a $250 million fund, that will force a lot of issues to the table before succession planning,” says Chip Hazard, a managing general partner with IDG Ventures. Adds Mark Heesen, president of the National Venture Capital Association: “Succession planning has been elongated. A lot of firms that thought they were going to have to deal with it haven’t had to deal with the issue head on because they haven’t been fund-raising.” Now that so many firms are raising new funds, the issue of who will lead a firm into the future can no longer be avoided.
Limited partners are keeping a close eye on the musical chairs to determine where (or if) they should place their bets. The general partner lineup of a new fund “is one of the most frequently asked questions from the limited partner community,” says Andy Rachleff, a founding general partner of Benchmark who is going part-time in its new fund. “The LPs have forced it onto people’s radar screens,” adds Partech’s Welsh. “A lot of venture capitalists knew it was an issue but didn’t want to deal with it. People now realize that they can’t afford to ignore it any longer. The LPs are telling people that they’re going to question them very directly about their succession plans. There’s still a lot of work for almost every firm to do.”
And LPs aren’t particularly thrilled with what they’re seeing so far. “There are a select few [GPs] who have done a great job and a select few that have done a terrible job, but mostly it’s to be determined,” says Ashton Newhall, a general partner in fund-of-funds Montagu Newhall. LPs aren’t just concerned that a firm may lose a rainmaker, but also that important knowledge and relationships aren’t lost when someone walks out the door. They very much want to see older GPs mentoring the up-and-comers. When Eugene Kleiner passed away last November, friends and colleagues cited his sage advice as a prime ingredient in their subsequent success.
LPs are putting general partners of their venture firms under a microscope and questioning plans and policies. A limited partner with significant venture capital exposure says that personnel changes at venture firms have been too abrupt and disruptive to produce good succession planning. “That abruptness is what people are starting to question,” says the LP, who asked not to be named. “The spinouts and the departures play hell with succession plans. That’s the risk that venture firms run by not having gotten ahead of the curve.”
“The results in our industry are pretty spotty,” concedes Peter Barris, managing general partner of NEA. “Some firms have done a very good job in terms of passing the mantle and others don’t seem to be doing anything. If anything, firms are downsizing their organizations so you don’t see any progress in terms of filling the ranks with younger people who could potentially become leaders.”
The KP Question
Even the best venture firms must take the time to inform not just their LPs but the general market of GP changes, or they may end up spending more time than they’d like going back to explain themselves and quash rumors. Witness what happened at Kleiner Perkins in the spring, after it came to light that four partners (superstar Vinod Khosla, in particular) would take a reduced role in the firm’s new fund and another partner would leave altogether. Kleiner Perkins didn’t issue a formal press release about its plans until Private Equity Week, VCJ’s sister publication, reported the planned changes in its general partnership. Its GPs didn’t return calls for comment for this story.
GPs at other firms, all of whom asked to remain anonymous, say Kleiner Perkins handled the situation poorly. A few months later, those GPs are still wondering how Kleiner Perkins will be affected by the changes. “From the outside looking in I would question what KP is going to do going forward,” says a general partner at a West Coast venture firm. The firm’s abrupt scaling down of the duties of a significant number of partners should cause alarm, he contends. Says another West Coast VC: “There’s been a lot of speculation about what’s going to happen when those superstars [at Kleiner Perkins] start to do other things.”
Kedrosky says that Kleiner Perkins does a better job of succession planning than others give it credit for. “KP doesn’t do a bad job of this,” he says. “They’re perceived as having a real star culture inside, but people are pushed through the process.” He adds that consistently mentoring people to be good investors is more important than having celebrity names as general partners in every fund.
Bob Pavey, a general partner with Morgenthaler Ventures, says Kleiner Perkins will get through the partnership change just fine. “My impression is that the leading firms that have recourses are in good shape,” he says. “I wouldn’t be the slightest concerned about KP or Sequoia. I would be concerned about small firms that are one- or two-people shops.”
Indeed, David Pinkerton, a managing director with AIG Global Investment Group, an LP in Kleiner Perkins’ funds, cites Kleiner Perkins and Warburg Pincus as two firms that have survived multi-generation management changes well.
Succeeding at Succession
During an Olympic relay race runners don’t stop when they’re handing off the baton, and those who receive it are running before the baton is put in their hand. Handing over the reigns of a venture capital firm should look as graceful as an Olympic relay.
One firm consistently cited for good succession planning is NEA. Possibly the most institutionalized of U.S. venture capital firms, NEA is also the most active. Barris describes how his firm handed power over to its next generation. The transition was gradual and took three funds to complete. The firm normally has one managing general partner, but it took an interim step of creating an executive committee of three general partners. (The members of the committee were outgoing managing general partner Dick Kramlich and two “next generation” GPs-Barris and Tom McConnell.) When the firm raised NEA VII, the committee of three served as the managing general partner. For NEA VIII, Kramlich gave up management duties, leaving Barris and McConnell as the two managing GPs. Finally, with NEA IX, McConnell resigned, leaving Barris as the sole managing general partner. McConnell has since joined Vanguard Ventures. Former NEA general partner Rob Coneybeer, who departed with the same fund, is a co-founder of Shasta Ventures. “I don’t know if I’d recommend something like [a committee structure] to a smaller organization, but it worked for us,” Barris says.
Summit Partners followed a similar strategy. Its three managing partners ran the firm much more like a business than a flat partnership. In 2000 they identified the firm’s key functions and chose the partners who would perform them. Summit did not create a committee like NEA; successive generations of managing partners worked in tandem. “We basically operated for a year in parallel prior to the handoff,” says Managing Partner Martin Mannion. “When we raised the new fund [Summit VI] it was the passing over to the new generation.”
Summit LP Christopher Wagner was pleased with what he saw. “They did a real good job of putting in place a team of bright individuals that had good experience up to the point when this set of senior partners left,” says Wagner, investment officer for the Los Angeles County Employee Retirement Association (LACERA). “That’s really the only group in our portfolio that has done that. The rest of the organizations that have done that haven’t gotten to the point where a group has decided to move out. Usually the senior partners have elected to stay involved in some way.”
Despite recent changes and doubts about the commitment of Sevin Rosen’s more senior partners, the firm’s limited partners had enough faith in its succession plan to commit again. But they didn’t ante up without due diligence. “We asked: How involved were the senior people like Steve Dominick and Steve Dow?'” says an LP who asked not to be named. “They had hired a bunch of operating guys without a lot of venture capital experience. We were comfortable because Sevin Rosen has a great process of having people work on troubled deals. It’s a pretty good training program. They’re only hiring people they’ve worked with for a number of years and have backed.”
Checking egos at the door is critical to making succession plans work. Bob Barrett of Financial Technology Ventures (FTV) is looking for his own replacement. “I head the software group and it’s fairly public knowledge we’re looking for someone to come in who is in [their mid-30s] and take my job running the software section,” he says. Last year FTV hired Brad Berstein, a 30-something private equity investor out of Oak Hill with a buyouts and business services background, to run its business services area and lead the New York office. “We now are taking an active approach to build up our resources,” Barrett says. “We’re taking a leveraged approach and have analysts, associates, principals and partners.”
ATV has gone so far as to write down its policies on how its partners are to exit the partnership. Once a partner decides to no longer be involved in the next fund, he or she slowly exits their board of director commitments. This gradual approach is the method preferred by entrepreneurs and limited partners alike. “It’s not a bad retirement approach,” says Raffel. “It’s not like you’re working and then you’re not and you get a gold watch and go off into the sunset.”
As venture firms become larger and the venture capital industry becomes more institutionalized, firms have taken steps to expand their support staff in order to decrease the administrative management burden on GPs. This follows the progression venture capital firms have made over the last decade in becoming larger and more cumbersome to manage.
IVP’s Dennis says that he wouldn’t want to run a firm with more than seven general partners, citing the IVP breakup as a cautionary tale of what happens when venture firms get too large. “There were so many people at partner meetings it was very hard to make decisions,” he says. “From the point of view of the investors it’s probably best that the reorganization did happen. Smaller firms managing smaller amounts of money probably have a better chance of success than big firms managing billions do.”
Other VCs note that if a firm can develop a deep enough back office, much of the managerial nightmare can be contained. Even staffers who aren’t general partners but assist in running portfolio companies are a helpful aid to growing venture firms. For example, venture firms are increasingly adding recruitment partners to help them find and coordinate executives in their portfolio companies.
“From an administrative standpoint, we have an officer who runs administration and finance. We believe the majority of our energy and time should be in investing,” says Sam Colella, an IVP veteran and current managing director with Versant Ventures. Barris says that the partners of NEA do as many deals as they did 10 and 15 years ago, despite being a much larger organization. He credits this to the widely expanded back office at NEA.
Spreading the management burden among junior partners is also a way for venture capital firms to prepare for succession. Having influence over the management of the firm builds cohesiveness and morale even if there isn’t necessarily a financial reward associated with the management duties.
Partech started a management committee about three years ago to help transition management teams in the future by spreading the management of the firm beyond the more senior partners. The committee meets every other month and as needed. It consists of founding partners Thomas McKinley and Vincent Worms and three other general partners who serve two-year terms. The entire partnership votes and elections are held on a rotating basis. Two seats and one seat are put up for a vote on alternating years. “The younger general partners have to be exposed to the management side of the business sooner,” says Welsh, an original member of the committee who was re-elected last November.
For today’s VC firms, the management burden is greater and handling the management burden is an essential part of the ultimate management transition. Today, more than in the past, GPs face more responsibility in managing their back office very closely and making sure that the reporting given to LPs is accurate and transparent. “The younger partners are going to have to bear more of the brunt of managing the business side of running a VC firm than they have in the past, where it was easier for one or two senior partners to run it all,” Welsh says. “Those burdens are becoming impossible and it’s not advisable for one or two partners to run the whole firm.”
All about the Benjamins
Attracting and keeping a talented team of future general partners requires financial incentives in the form of a relatively equitable carry structure. “You have to ask: Do the folks that are running the show have a piece of the action?” says Warren Haber, a partner with Mellon Ventures.
Firms need to balance the need to reward individual performance with the need to foster a cohesive and loyal partnership that shares equally in the success of its funds. A relatively flat carry structure is a key ingredient in making sure a strong team will stick around. However, most venture firms are set up as a hierarchy, not as a flat partnership where everyone shares equally in the profits. “When I came into this industry in 1992 the dominant model was hierarchical,” says NEA’s Barris. “You had one or two people at the top of the pyramid who got a disproportionate part of the carry. Young people pushed and split their firms apart when there was no give. My impression is that it’s more relaxed but that there are still plenty of examples of that kind of hierarchy.”
“We do not like the idea of subjectivity related to compensation,” says Wes Raffel, a general partner with Advanced Technology Ventures (ATV). “We don’t do it that way. Once you’re a general partner, everything is equal.” It’s not as easy as it sounds, of course. “You have to give something up if you want to be equal; you have to be pretty magnanimous,” Raffel notes.
“Bottom line: It’s dollars,” says Tom Crotty, a general partner at Battery Ventures. “It’s the age old problem of the older guys who feel they built the firm and created the value not necessarily wanting to turn the value over to younger guys who feel they’re carrying the firm and doing the work. It doesn’t matter if it’s an up period or down period. These general succession issues boil down to individuals, their personalities, their greed and things like that.”
While GPs are paid a salary and a bonus, the real money comes from carried interest. And that’s where disputes arise and can lead to GPs walking out the door. “A lot of firms that went though transitional difficulties found it was related to inequities in the carry structure,” says John Jaggers, a general partner with Sevin Rosen. “If you have a senior partner that’s got a lion’s share of the carry and they decide to carve back, you have to be careful how you carve that carry back.” Witnessing transitional difficulties that occurred among VC firms in the 1980s influenced the “flat carry structure” that Sevin Rosen implemented more than 10 years ago, he says.
Reconfiguring carry structures is very common at the moment, says AIG’s Pinkerton. “There’s basically some very established venture funds that are in fund five, six or seven, and they have a natural need to reshuffle the carried interest deck and put in the next layer of up and coming general partners,” he says.
GPs who go part-time have to be sensitive that their fellow GPs who are working full-time may not want them to have any carry at all. When someone goes part-time, the general partners typically negotiate what the split should be, a process that can be contentious.
To avoid potential conflicts like that, the founders of Benchmark set up their firm as an equal partnership. “We decided that having seen other firms go through generational transitions that we were going to do it differently,” Rachleff says. “So we told all of our limited partners when we got going that we were going to share everything equally, even as we brought in new partners.”
Benchmark was set up so that when a partner goes part-time, as Rachleff is doing with Fund V, he replaces his equity position with cash. That, Rachleff says, “eliminates the hanger-on syndrome. You don’t have guys who are working part-time and drawing a carried interest based on the fact that they were founders.”
So how will Rachleff stay motivated in the new fund’s success? He is a “sizeable investor” in the fund, so he has a keen interest in seeing it succeed.
Beyond Your Control
Sometimes all the planning in the world won’t prevent a firm from splitting apart. A source familiar with the IVP breakup says the instant wealth created by the Internet bubble-more than any other factor-made it virtually impossible for the firm to continue. Dennis did what he was supposed to do: He had dialed back his time, handed off the informal leadership role of the firm, and he was taking a reduced carry, the source says. “In terms of management and economics, [Dennis] was doing the right thing; he never got in anyone’s way,” he notes.
But the Internet bubble came along and suddenly the firm’s GPs were surprised by their newfound wealth. IVP’s $350 million Fund VIII (raised in 1998) was valued in excess of $1 billion in 1999 and its two prior funds also had returned more than $1 billion, says the source. On average, the firm’s GPs were worth about $100 million apiece, at least on paper. “The funds had done so well that everyone was feeling independent,” the source says. “They didn’t feel beholden to anything or anyone.” At the same time that the partners came into all that wealth, they were “feeling overworked” trying to put money to work in a frenetic deal environment and getting stretched thin by too many board seats, he says. “You can do all the succession planning you want, but if the partnership puts its collective mouth on the end of a fire hose and the water starts gushing, it’s hard to tell if any of the planning will work out.”
Many in the industry estimate that there will be a continued shakeout in venture capital. “It’s still unclear on these 1999-2000 funds how bad the carnage is really going to be. There are still issues with some very reputable high-powered names and the investors and we may not know all the info yet. There are some very large funds that may not return any capital,” says Barrett of Financial Technology Ventures.
Kedrosky estimates there will be another “big die- off” in 2006, which will solve part of the problem. “People forget it’s really unusual for LPs to claw back their capital. These things tend to die a death at the end of the funding cycle. That’s when you tend to see the die- off. The life span of the funds raised in the circa 1998 to 2000 era was 2005 to 2007.”
“A lot of those decisions are being mulled over this year. A lot of venture firms are deciding whether or not to go back out into the market,” says Michael Hoffman, president and founder of recruitment firm Probitas Partners. “It’s really a very dynamic time with regards to venture funds.”
“You’re probably just seeing the tip of the iceberg,” adds Mannion of Summit Partners. “A lot of funds were raised in 1998 and later. They have seven-year investment horizons that are starting to come to a close. That’s usually a good time for the partners to evaluate what’s left for the partners to do.”
Then again, people have been warning of a major turnover in the ranks for some time. “Two years ago there were rumors that a lot of the older more successful VCs would just retire and that a lot of people were going to disappear,” says Ray Rothrock, a managing general partner at Venrock. “My peers-guys I know that have been in it as long as I have and maybe even managing partners-are all still working hard. At the end of the day, this is a fun business, even if it’s hard and sometimes painful. We’re very driven, very motivated. We’re here for a lot of other reasons besides just making money.”
For LPs who want to stay on top of who’s actually investing their money, Mike Kelly of Hamilton Lane advises them to be proactive. “Talk to VCs about other VCs, and during the diligence process talk to portfolio company executives,” Kelly says. “Understand who’s really active and who’s not, so when it becomes time to do the diligence you’ll be much better prepared.”
While many LPs insist that they will keep GPs’ feet to the fire on the issue of succession planning, some are skeptical about how committed they are. “At the end of the day LPs are going to fold up their tent in the face of performance,” Kedrosky says. “If someone else brings better performance to the table, all this talk about succession planning goes out the window. It’s not as important to them as bringing in big numbers. But how consistent are those numbers going to be if there’s not stability in the team?”
And despite an increased awareness and the industry’s best efforts, it may not always be possible to keep some good venture capital firms going. Some firms may be happy to split apart when its senior partners retire. “At the end of the day this business is driven by the talent of individuals and it’s not always going to be possible to have multi-generation success,” says Pinkerton of AIG Global Investment Group. “It’s very unusual and rare to have a firm that has the culture and can transfer the excellence from one group to the next. It’s as much art as it is science.”
SIDEBAR: Succession Planning To-Do List
- Involve junior partners, associates and vice presidents in the management of the firm early on in their tenure. Form a management committee if necessary.
- Have a flat carry structure that gives all general partners an equal share of returns.
- Transition gradually between management teams, over several funds if necessary.
- Keep outgoing and retired partners active in the firm.
- Hire sufficient back office/administrative staff to allow partners to focus on investments.
- Keep in close contact with limited partners regarding the future plans of general partners.—Matthew Sheahan
Additional reporting by Lawrence Aragon