Tallwood Branches Into Institutional Money –

Serial entrepreneur and angel investor Dado Banatao has built semiconductor companies that already have a legacy in the technology world. He wants to do the same with his venture firm, Tallwood Venture Capital.

Founded in June 2000, the Palo Alto, Calif.-based fund was primed with $50 million of Banatao’s own money. By any measure its investments have been a success. But to build a firm with long-term ambitions, Banatao says he needed to bring in institutional investors. Tallwood has done that in spades, closing Tallwood II, a $180 million fund, in October. It is backed by endowments from Harvard and Stanford, as well as pension plans from New York, California and Oregon, among others.

“If you want to set up something for 50 to 100 years, you need to play with these guys,” Banatao says. “Since we want to make this a long-term firm, that is what we did.”

Fund-raising began in March, and though the fund was oversubscribed in the end, it took longer than the Tallwood team expected. “It’s a tough fund-raising environment,” says Tallwood General Partner George Pavlov. “The bar is relatively high in the eyes of potential investors and the decision cycles were longer than they might have been.” Pavlov is a former general partner at Mayfield, where Banatao was a venture partner from 1998 to 2000.

The addition of institutional investors changes some things from the days when Banatao invested his own money, says Banatao. It will result in investing more money per company and a more formal structure for that investment, he says.

“When I was investing my own money, if I felt good about a company I would put money into it,” he says. “Now that this is a formal fund, we do have to look at the technical side of the money-you have ratios that you need to look at in terms of Series A and Series B rounds.”

What won’t change is the hands-on approach that Tallwood brings to every company in which it has an interest. “In the beginning, after we invest in a small company of entrepreneurs, we fill in the role of the business manager for the company,” Banatao says. “We do staff meetings on a weekly basis if necessary, and these are real working sessions. We are part of the management team.” Because of that hands-on approach, Tallwood limits itself to no more than five new deals per year.

Banatao and Tallwood General Partner Ron Yara co-founded Chips & Technologies (later bought by Intel) and S3 (now SonicBlue). The two have a history of creating successful companies and bring that expertise to their VC investments. They leverage that experience by investing only in what they know-semiconductors, Banatao says. “If you invest in semiconductors, you better understand technology,” he says. “It’s all about technology.”

Within the $140 billion semiconductor industry, Tallwood will look to invest more than 90% of its fund in chip or chip-related companies. Its principal focus is on companies that build semiconductors for the computer and communications industries, and about 95% of those deals will be Series A, Pavlov says. The average deal will max out at $10 million per company.

Tallwood II has already made its first investment, a $3.2 million Series A deal in Axiom Microdevices Inc. of Orange, Calif. U.S. Venture Partners also has a stake in the company, according to researcher Venture Economics (publisher of VCJ). The stealthy Axiom is working on “advanced RF integrated circuits for mobile telecommunications,” according to a description on USVP’s Web site. Other investments might be made in companies with technologies or tools for designing chips or, on a very rare occasion, companies developing new materials for use in chip manufacturing.

Tallwood is clearly optimistic about an industry that has been in a pronounced slump. Industry leader Intel is forecasting lower revenue in the fourth quarter with no sign of a recovery looming, while rival Advanced Micro Devices is scrambling for ways to cut $350 million in operating costs.

So why is Tallwood so fired up to invest in chips? Because the chip industry is cyclical, and it always comes back, says Kevin Krewell, senior analyst with InStat/MDR. “I think it’s a great time to start one of these funds because the lead time to bring a new chip to market is one to two years,” Krewell says. “It’s just a matter of saying, Let’s make the investment and look at something that pays back big in two years or so.'”

Sounds easy, but it takes guts to follow through. If Banatao’s iron stomach and the cycle hold up, Tallwood-backed startups may be right on the cusp of the next wave of chip-buying, making Tallwood’s new investors very happy that they bought into Banatao’s plan to build a legacy firm.