The overriding theme of 1998’s venture capital fund raising can be summed up very simply: more. Make that a lot more.
VCs raised $24.34 billion in 200 funds last year, according to figures released by Venture Economics Information Services, a data company related to Securities Data Publishing, which owns Venture Capital Journal.
That’s about $10 billion more than 1997’s total and $14 billion more than 1996’s. It is worth pausing to recall that 1996 was the first year the venture industry crossed the $10 billion fund-raising mark, according to updated Venture Economics statistics.
It also should be noted, however, that 1998’s figures include a $5 billion fund raised by Warburg Pincus Ventures Inc. Managing Director Bowman Cutter acknowledges that the firm’s vehicles are difficult to categorize, but he argues that “venture” is the most accurate description of Warburg Pincus’ investment approach (see sidebar).
Even without Warburg Pincus’ contribution, however, 1998 would have set a venture capital record.
Pensions were a major player in last year’s fund raising, putting up 60% of the capital raised. That’s almost twice their 1997 commitment level. Observers note that pensions have done quite well in both the public and private equity markets in recent years and, therefore, have had considerable capital to spill into the venture arena (VCJ, February, page 5).
The participation of endowments and foundations dipped to its lowest level in five years – to 6% in 1998 – and high-net-worth families and individuals receded to 10.6% from 1997’s 15.2%. Corporate participation also fell slightly, to 11.4% from 1997’s 12.1%.
Insurance companies, not a major player in recent years, all but evaporated in 1998, putting up only three-tenths of 1% of the capital raised.
Insurers All but Leave VC
Eric Gritzmacher, vice president in charge of private securities at Pacific Mutual Life Insurance Co., was not surprised that insurance companies were such a small part of last year’s total, especially when compared with pension funds. He points to several differences between the two types of institutions as reasons why insurance companies lag so far behind, including that they have more immediate liabilities and are subject to legal restrictions that discourage VC investing.
In addition, insurers must take risk-based capital charges, meaning they have to set aside capital on the equity part of their balance sheets for each asset they buy. The amount that must be set aside is considerably less for lower-risk investments such as government bonds and considerably higher for riskier investments, such as stocks and private equity. Hence, it is simply more expensive for insurance companies to tie up money in venture capital, Mr. Gritzmacher notes. Finally, insurance companies have to contend with rating agencies – which do not look kindly on risky investments.
Pacific Mutual, however, invested in two venture capital funds last year: Mission Ventures and Landmark Equity Partners VIII. Mr. Gritzmacher makes his decisions opportunistically and figures he could back 10 funds this year – or none.
Rarely does he consider Northern California VC firms, although he makes an exception for Menlo Ventures, with which the insurance company has invested since Menlo’s first fund in 1976.
“I can’t figure out who’s going to win,” Mr. Gritzmacher said of Silicon Valley VCs. “They all see each other’s deals.”
When Aetna Life Insurance Co.’s in-house venture capital expert left to start his own firm in 1993, the insurance company pulled back from venture and turned its attention to buyouts. Part of the motivation for the shift was one of manpower: Aetna’s three-person private equity team – which has a mandate of committing $50 million a year – would have difficulty keeping up with the number of venture firms needed to hit Aetna’s investment target.
“We wanted to put out some larger chunks of dollars,” says Allan Vartelas, the team’s managing director.
Not Many Investment Surprises
Overall, the insurance dollars that did find their way into VC last year – along with all the other types of investors’ capital – went to the expected places. Not surprisingly, general partners with more experience were rewarded with more capital. Late-stage funds lost ground, as they did in 1997, while early-stage funds’ take increased slightly. Without Warburg Pincus’ money (technically categorized as a “private equity” fund), balanced vehicles took a smaller piece of 1998’s pie than of 1997’s, but if the Warburg Pincus money is included, balanced funds took a bigger piece in 1998 than in the year before.
Barr Dolan is not shocked. As part of the Charter family of funds, he is a general partner in a later-stage fund (Charter Growth Capital, L.P.) and a managing director of an early-stage effort (Charter Ventures III, L.L.C.). Both funds rounded up money in 1998.
“They’re interested in anything with Roman number two or more on it,” Mr. Dolan says of investors. They are enthusiastic about early-stage funds, but there is a limit to how much they can wedge into those vehicles, he adds.
Mr. Dolan would not be surprised to see the launch of a later-stage fund targeting $500 million to $1 billion in 1999. “The money is there, and these guys want to take it,” he said of his fellow VCs. Charter, however, is not planning to raise such a vehicle.
Looking to 1999
As for this year, Mr. Dolan observes venture investors’ strong desire to stuff more money into the asset class. Many of the industry’s most prominent groups, however, raised capital in 1998, which leaves fewer big names to come to market this year.
Weighing those two trends, Mr. Dolan figures 1999 totals likely will match 1998’s, not including the Warburg Pincus fund.
John Mumford’s firm, Crosspoint Venture Partners, will be among the groups hitting the fund-raising trail this year. The vehicle is slated for a second-quarter launch and will target $175 million. The firm makes seed and start-up investments, putting about 80% to 85% of its money into Internet companies and the remainder into health care. Like Mr. Dolan, Mr. Mumford has observed a keen L.P. appetite for proven early-stage venture firms.
Interestingly, Crosspoint’s investor base is heavy on university endowments and foundations – not the big players in 1998 – in addition to a few pensions.
Mr. Mumford’s prediction for 1999’s venture fund-raising total is right in line with Mr. Dolan’s. “I’d take 18 (billion dollars) as a number,” Mr. Mumford says.
While the venture industry waits to see how this year’s fund-raising environment shapes up, Abbott Capital Management Managing Director Stan Pratt preaches the gospel of discipline. Venture firms must show discipline – creating proprietary deal flow, rejecting overpriced deals and being willing to do a quality deal that others have rejected because they think it’s overpriced. VC backers should not slack off either; they must scrutinize venture firms before investing, Mr. Pratt says, warning that too much money is going into untested hands, conjuring up memories of the venture industry’s tough times in the 1980s. “Too many people thought they walked on water, and people were throwing money at them,” he recalls. The lesson, Mr. Pratt says, is that walking on water is a good way to get wet.