Accel Partners learned the hard way that limited partners really do have more clout today. Its partners put on a brave face after the firm announced that it was cutting back its latest fund, but they had to have been grimacing on the inside: After more than five months of designing a fund-split plan and trying to sell it to investors, they had little choice but to cave in to LP pressure.
The firm’s odyssey began last fall, when Accel investor Flag Venture Partners sent out its quarterly Venture Insights newsletter. In its market commentary, Flag predicted that VC firms soon would be forced to confront issues of oversized funds and incentive realignment. Moreover, Flag suggested that the solution most amenable to both LPs and GPs would be to split funds in half so that capital call-downs would be reduced in the short-term while overall capital commitments would be maintained in the long-term.
The idea immediately struck a cord with Accel management, which already knew that it might have to deflate the $1.6 billion it raised in 2000 through its $1.4 billion Fund VIII and $200 million strategic side vehicle.
In the waning months of 2001 and the beginning of this year, Accel began trying to apply Flag’s general prescription to its specific case of bloated fund. The Palo Alto, Calif.-based general partnership consulted just about everyone, including some of its limited partners.
Accel Falls Into Context
As Accel continued discussing the nuances of its new proposal, many in the limited partner community were beginning to experience a newfound sense of entitlement, as one sizable fund after another began to scale back its size – and fees.
During the late 1990s, many venture capital firms began increasing fund sizes, management fees and carried interest percentages to reflect outrageous Internet era returns. Once the bubble burst, however, limited partners were struck with those “premium” fund structure components even though returns had often fallen through the floor.
To appease investors, certain firms began either reducing management fees or simply telling investors that they’d call down less capital than had been originally committed. The first example of the latter approach was Mohr, Davidow Ventures, which in February trimmed its seventh fund by 20%. Next up came a 25% cut from Kleiner Perkins Caufield & Byers, a firm held in the highest possible regard by most institutional investors.
Limited partners took the MDV and KPCB decisions to mean that GPs finally understood investor frustration with Internet bubble structures being maintained in the midst of an economic downturn. Moreover, the fact that both MDV and KPCB followed a very similar course of action led many to believe that straight-up fund size reductions would be the way of sating investor concerns in the future.
But Accel had no intention of following the path more traveled. When asked if the firm would follow the KPCB model as some LPs had suggested, a source associated with the firm replied: “Not a chance.”
Instead, Accel had gone full bore on its proposal to split its fund in two and was just including a few finishing touches before approaching its investors. At the end of March, Accel informed limited partners of its plan, and told them that a two-thirds majority vote would be needed to put the fund split amendment into play.
Coincidentally, news of the Accel proposal was leaked to VCJ sister publication Private Equity Week on the very day that the newsletter’s Web site also reported Redpoint Ventures’ decision to enact a pure fund cutback. It was almost as if LP sources were trying to tell Accel that it was out of step with the rest of the market.
“I’m still not sure I get it,” one Accel investor said after receiving information on the fund split plan. “I mean, it’s in front of me and I understand what they’re trying to do, but I still don’t get it.”
Splitting the Base
Considering that the fund split idea had originally come from a limited partner, Accel may have been a bit unprepared for the blitz of discouraging press it received once word got out. Many investors were upset that they wouldn’t be getting any of their committed capital back, while others complained that the proposal was really a ploy to lock in Fund VIII’s 30% carried interest for a lengthened period of time.
Alan Austin, a general partner and chief operating officer with Accel, believes that both concerns were overblown. It wasn’t like investors were losing any money or being asked to increase their investments, Austin says. Instead, they were simply maintaining commitment levels they had already agreed to. Moreover, those commitments would now be carried over into the new Fund IX, thus erasing the possibility that certain investors may be denied the right to exercise pro rata options.
Further, Austin says, even though the carried interest percentage would remain, overall management fees would actually decrease. The rationale here was that the new Fund IX would launch immediately, even though it wouldn’t actually begin collecting management fees until it started investing a few years down the road.
“While they support our effort to address the fund size issue, some LPs have said they’d like flexibility to reconsider their commitment level in the future depending on conditions at that time,” Austin told PE Week in early April. “The answer is that we’ve tried to structure this in such a way that Fund IX interests would be extremely marketable since there would have been no capital draws or fees paid. In essence, Fund IX would be a clean sheet of paper.”
Accentuate the Positive
The resonance of Austin’s argument seemed to depend largely on who was listening. For fund-of-funds (FoF) managers, the response was generally positive. Even though the fund split required such groups to engage in some allocation and ERISA maneuverings, the general feeling seemed to be that it was important to stay in Accel’s good graces. After all, a FoF basically markets its GP relationships to potential investors. “Everyone is looking for good returns, but fund-of-funds are also selling access,” explains a pension fund manager.
In addition, it was important for FoF managers to maintain their initial commitments, even if it meant that some of them would need to revisit closed, vintage year funds. Unlike a pension fund manager who can just throw returned capital back into the larger pot, a FoF would have to go out and find a new fund in which to invest its returned Accel commitment. That’s a tough task considering today’s dearth of quality VC fund offerings.
Reaction to the Accel proposal was not nearly as supportive from the endowment, private foundation and pension fund sectors. Many of these groups wanted a pure fund reduction like they had gotten from MDV, KPCB and now Redpoint. Moreover, many Accel LPs were also investors in Charles River Ventures, which had already told them that it was considering a 50% cut on its $1.2 billion Fund XI. (It actually cut its fund to $450 million in May.)
Some of these disagreements came to a head during Accel’s annual LP meeting in mid-April. The meeting was marked by an abundance of candor, and it seemed to some attendees that at least a few of the differences were on their way to being ironed out. Moreover, the firm implied that it was inching toward its 66% majority vote, indicating both increased acceptance and the possibility that dissenters may soon have to swallow a disagreeable loss.
The meeting’s most significant result, however, was that the Accel partnership began to more clearly see how investor dissention could hurt the firm, even if the dissenters weren’t strong enough to beat the fund split vote. This recognition was most evident on April 29, when Alan Austin sent an email that, in part, chastised LPs for press leaks. “I wish I could report that our LPs have all respected the confidence of our communications, but unfortunately within 24 hours after the meeting we started getting calls from reporters,” the email read. “We don’t understand how it is in the interest of any partner to share confidential information with the world, and frankly we are disappointed.”
Like a Hanging Chad
The final step toward firm unity came on May 6, when Accel told investors that its executive advisory committee had voted unanimously to shelve the fund split proposal. In its place, Accel chose to follow the pure fund reduction model by lopping approximately 32% off of its $1.6 billion worth of committed capital.
Austin claims that Accel had enough votes to pass the fund split, but that the plan was abandoned in favor of trying to do right by the largest number of investors.
“It’s about what is the right thing to do… the outcome that will deal constructively with the issues and create the greatest satisfaction in the LP base,” he says.
It seems to have worked. LPs contacted for this story say they were pleased that Accel decided to enact the pure fund reduction, although a few wished that the cut had been a bit deeper.
“This is what we’d hoped for, so we’re glad that Accel did what I felt was in everyone’s best interest,” says one institutional investor. “I wasn’t always too confident it would happen, but I guess they saw the light.”
Another Accel investor added that the decision proves the firm is made up of “reasonable people” who recognize there is little reason to “alienate half of [their] LPs.”
Indeed, the only question still lingering is why it seemed to take Accel so long to recognize what seemed fairly obvious back in March: that most investors felt a pure fund split would be the optimal approach.
Rick Boswell, a general partner with St. Paul Venture Capital and a member of the Accel executive advisory board, believes that the lag time was the mark of a responsible venture capital firm. “I didn’t feel there was a clear benefit to one choice over another, but at the end of the day, management of Accel listened carefully and made its decision,” Boswell says. He adds that he didn’t feel that the period between the fund split proposal and retraction was particularly long, nor did he feel that the process involved much controversy.
He did say, however, that the fact that Accel considered any sort of fund amendment is a sign that limited partner concerns have gained significant momentum in recent months. And he agrees that Accel’s decision to abandon its proposal could hinder other firms that may be contemplating a similar proposal.
One LP, apparently channeling Yogi Berra, sums up the Accel experience this way: “The ball was in our court, and we hit a home run.”
Contact Dan Primack at