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A House of Cards
Eileen P. Gunn
04/01/2004
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Meanwhile, investors appear to
be looking to invest in venture capital again. But, still suffering investment
hangovers from their venture firms’ boom-time excesses (and their own
overindulgence in this risky asset class), they are going out of their way to be
prudent about it. They want even favored firms to demonstrate that their
investors’ best interests are the top priority, that they can provide reliable
performance data, and that they have forsworn the hubris and sloppy investing
habits that they succumbed to during the bubble.
“When venture capital firms
come around to raise money, people are going to consider whether they’ve done
right by their investors,” notes Andrew Craighead, managing director for
alternative assets at JP Morgan Chase’s private bank. “That’s not just a matter
of returns,” he argues, referring not to investment returns, but to monies
returned to investors by venture capital funds that found themselves unable to
put it to good use. Attracting investors will also require lowering the
management fees that had risen too high, and downsizing the funds that were too
big to manage, Craighead says. Investors will also weigh whether the funds
delivered bad news in a timely fashion.
The tribulations of Vanguard
Ventures—a well-respected seed-stage firm in Palo Alto, Calif., that counts
numerous individuals and family offices among its long-time investors—illustrate
some of the problems facing investors, funds and portfolio companies. General
partner Donald Wood reports that 85 percent of its companies are still
operating, and fewer than 5 percent of his investors have tried to sell their
stakes on the secondary market. Despite this, it has not been easy-going. The
partners had to ask investors in their $100 million 1998 fund for an auxiliary
fund when they ran out of money, and their portfolio companies needed additional
rounds of funding to sustain them to exits.
Vanguard invests in start-up
companies at low prices, helps them grow, and sells equity stakes to bigger
venture capital firms at higher prices when the companies reach greater
maturity. But those later-stage investors have lately had their own stagnant
portfolios to carry, and they have not been seeking new investments—at least not
without forcing markdowns in value that might or might not be deserved. “Instead
of having A, B and C rounds [of financing], you have A, B, C, D and E rounds
these days,” says Wood, and the original investors have to get through each of
them without new firms coming in. “So we needed more money to support the
companies we still believe are good companies,” he adds, until the firm can find
exits for them.
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