As the venture capital industry races toward yet another record-breaking year for fund raising, industry professionals are asking some now-familiar questions: How much capital is too much? Where will it all go? When will the gravy train end? As ever, with the increase in the number of dollars raised and in investor commitments to the asset class, there are as many opinions as there are questions. Gatekeepers and limited partners concur, however, on this point: as long as there is the perception that returns are strong and there is pressure placed on institutional investors to diversify, venture capitalists will be able to raise more money.
By 30 June, 62 venture firms had raised $7 billion, according to figures compiled by Venture Economics Information Services. This figure is 55% greater than the $4.5 billion collected during the first six months of last year and nearly as much as the $7.5 billion raised in all of 1996.
Additionally, the venture industry has seen fund-raising totals increase incrementally each year since 1994, as well as more than doubling every two years. For instance, the total in 1996 was twice the amount of the $3.8 billion raised in 1994, and the 1997 figure is more than double the $4.4 billion collected by venture funds in 1995.
What’s more – and probably not surprising – is that 22, or 35%, of the 62 funds were oversubscribed. At the current pace, venture capital funds could conceivably secure $14 billion by year’s end.
Pressure to Diversify
The fund-raising bonanza is certainly born out of the fact that almost all institutional investors have allocations to the public markets and as such have experienced strong stock returns. Many have found themselves overweighted in public equities and in need of diversification.
As well as a raft of consultant searches and asset allocation studies, this phenomenon has resulted in certain investors adding an alternative assets allocation to their portfolios, while others have boosted their alternatives programmes. “Many institutions need to rebalance their assets and for the time being, private equity is one major area that has had a lot of success,” says Barbara Braun Schoenfeld, deputy treasurer of the Rhode Island Retirement Systems. “You don’t want to be too tidy about rebalancing, but there is definitely a lot of pressure from diversification needs.” Last February, Rhode Island boosted its alternative investments allocation to 7.5% from 5% and has since remained an active investor in venture partnerships, the most recent of which was the $170 million Alta Biopharma Partners fund, which closed in March.
Other investors within the past year that have either added alternatives to their asset allocation mix or increased their commitments to the asset class include the New York City Retirement Systems, the Massachusetts Bay Transportation Authority, American Airlines, Mobil Oil Corp., Louisiana State Employees Retirement System, the Houston Police Officers Pension System and the Ohio State Teachers Retirement System, to name but a few.
All of these investors had two things in common: they saw what they perceived to be good returns in the asset class and they were under pressure to diversify.
When the issue of diversification is raised, some gatekeepers say that the value of hiring private equity firms to invest money in the asset class – as opposed to a directs program – justifies the cost of carry and fees. And when advising investors about private equity, gatekeepers look at the long-term risk in committing to the asset class. “With private equity, it’s typically a ten-year bet and the chances of actually losing money are low if you get into the right funds,” says Clint Harris, a former partner at Advent International and founder of the new advisory firm Grove Street Advisers. “If board members [at institutional investors] used just a fraction of the brain power that goes into evaluating equity investments, they would see significant returns in private equity.”
Less Competition?
Despite this being a venture capital firm’s fund-raising market, many firms have been doing what they can to make themselves more attractive to investors by offering more opportunities for better returns, even while increasing their assets under management.
Most venture firms have taken the route of becoming more industry-specific in order to secure better returns or have moved into less competitive areas of the country such as the Midwest or the Southeast. But location and sector specificity do not guarantee good performance, and already there are signs that even these options are becoming over-run with competition.
Michael Henos, managing director of Atlanta-based Alliance Technology Ventures, recognizes the advantages of being a regional investor because of the generally lower cost of doing business. But lately, like many other regional investors, he has been beaten on a number of transactions by firms with both a national presence and more money that tend to over-inflate deal prices. He declines to reveal any details about lost deals.
Chris Grant, a partner at Tennessee-based healthcare investor Salix Ventures, says he has observed the same trend. “Even though there is generally less competition now, I’m talking to a guy at a company that really only needs no more than $4 million, and there’s already more than that being offered,” he says.
Salix Ventures does not specifically focus on Tennessee or the Southeast, even though it gives preference to those deals, mainly because the firm is already sector-specific with its focus on healthcare. Salix wrapped its first fund at $60 million in January.
Even though his firm is sector specific, Chris Grant also expressed concern that too much money sometimes finds its way into a given sector, which results in too much money chasing the same deals.
As for the institutional investors, their knowledge of specific sectors varies from limited partner to limited partner.
“With the exception of corporate funds, which may know their given area of business, most [LPs] don’t know specific industries very well,” says Rhode Island’s Barbara Schoenfeld. “The most challenging aspect is that you never have all of your [investment] options in front of you. You just do the best you can with the better opportunities that are in front of you at the time.”
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