Sevin Rosen Revisited

Last month, I spoke to a class of MBA candidates and fellows at MIT’s Sloan School of Management. The topic was the interaction between businesspeople (i.e., the future them) and business journalists (i.e., the present me). One point I emphasized was that they should always try to get out in front of a breaking story – particularly if the story is negative or could be misconstrued negatively. Putting one’s head in the sand only provokes reporters to begin kicking up the beach. 

No one from Sevin Rosen Funds was in the classroom that day, and they needn’t have been. It seems they already had internalized the lesson.


Last week, SRF spoke with New York Times reporter Gary Rivlin, who in 2004 had profiled the firm in a piece titled “Why Venture Funds Don’t Want Your Cash.” That article had come just as SRF was closing a new fund at $300 million, despite over $1 billion in verbal interest. The more recent conversation was of a similar vein, except that SRF now told Rivlin that it was postponing a new fund close that had been slated for this week.


Rivlin directed the firm to a Silicon Valley-based reporter named Miguel Helft, who spoke with SRF partner Steve Dow, and who also was given an explanatory letter that had been emailed to prospective LPs. Last Saturday, Helft penned an article that portrayed SRF as being one of the few firms with the courage to pull its money from where its mouth was. Similar press coverage soon appeared elsewhere, as Dow was extraordinarily accessible (as was the letter). He spoke with the Wall Street Journal, CNBC and myself, among others.


I don’t know who organized this press strategy – Dow? SRF marketing director Jennifer Michalski? – but it was extraordinarily effective. Stories like this usually begin with a trade reporter getting a copy of the letter, and then the firm refusing to discuss “confidential correspondence with its LPs.” The result is journalistic suspicion of internal firm trouble, whether it be partnership discord or fundraising difficulties. Those suspicions are almost always confirmed.


In this case, however, SRF got far enough ahead of the story that almost all the coverage was positive. There was some published doubt from the blogosphere, but even a cynic like me was relatively charitable (although I did express some disagreement with SRF’s basic premise).


Good for them, since that will be where they story ends for most casual business news consumers. But the reality, of course, is a bit more complex:


Back Story
SRF genuinely believes that the VC model is damaged. It is not spin, nor is it an attempt to cover up its own inadequacies.


Steve Domenik, for example, was quoted in a January 2005 BusinessWeek article that it would be “hard for the VC industry to make money if it’s deploying more than $10 billion a year,” (VCs disbursed over $22 billion in 2005). During this past May’s annual LP meeting, John Jaggers gave a presentation in which he displayed multiple graphs about how the market was raising more capital than it could responsibly invest or exit. In short, SRF has given this matter an enormous amount of thought.


During that same meeting, however, SRF told investors that it was going back to market with a ninth fund that would raise between $300 million and $350 million. The contradiction apparently didn’t faze too many LPs, who had seen plenty of similar situations play themselves out in the past.


“Sevin Rosen was basically telling us that there are some fundamental flaws in the VC business model, but that they’d be smart enough and diligent enough to sidestep them,” says one attendee. “Even the best of the top-tier funds tell us that.”


But the bigger problem for Sevin Rosen was that it was no longer in that crème de la crème category. Its first five or six funds – dating back to 1981 – had been absolute knockouts, but its more recent efforts had flagged.


Part of this was simply a result of industry cycles, and Sevin Rosen’s continuing emphasis on the troubled communications and chip sectors (although its portfolio is more diverse than some have claimed). There also was some occasional strategy drift, as best evidenced by last fall’s decision to lead a $26 million Series D round for Firefly Mobile, which provides cell phones for pre-teens and their parents. 


Not only was FireFly’s consumer-facing strategy a bit outside of Sevin Rosen’s traditional competency, but it also was a late-stage deal at a pre-money valuation of around $100 million. SRF was still upbeat about Firefly during last May’s LP meeting, when it gave out the company’s handsets to attendees. Nine months later, however, Sevin Rosen wrote off the entire investment, after deciding to not participate in a company recapitalization. There have been a series of other severe write-downs or write-offs in recent months.


SRF also had some serious succession concerns, since it had no partners under 40 and just two under 50. Part of this was exacerbated by a decision within the past year to push out three younger partners — Kevin Jacques, David Shrigley and Amra Tareen – who had joined during the bubble madness.


In addition, there were some exceptionally large track record variations between the firm’s best and worst performers – including a geographic split that saw the Dallas office generally outperforming the Palo Alto office. This sort of thing happens at most firms, but gets amplified at a shop that already is reexamining its entire strategy.


SRF, of course, continued on with its fundraising, and had soft circled over $200 million for this week’s expected first close. Plenty of LPs remained attracted to the brand name, the abilities of certain partners and the basic fact that SRF really did seem to have thought through many of the challenges that lie ahead.


But Sevin Rosen had a change of heart at the last minute. It had continued to crunch the industry numbers during the fundraising process, and had become more and more convinced of its initial thesis. The VC model wasn’t dead, but it was “broken” or “damaged.”


For example, it found data showing that 1997 was the last vintage year when the average value distributions divided by committed capital was greater than one. In other words, it’s been a while since the typical fund has done much more than return committed capital.


After much internal discussion, the firm suspended fundraising until it could come up with a more reasonable investment strategy. It also made a partnership change, with Steve Domenik agreeing to leave the firm. It was at this point that SRF spoke with Gary Rivlin, thus launching the PR blitz. I’m just speculating here, but I’d suggest that SRF will come eventually return to market with a much smaller fund target, and a few fewer partners.


Steve Dow reiterated yesterday that this story is not about Sevin Rosen, per say, nor even if the firm continues to exist. Instead, it’s about the overall venture capital model. But, for trade writers like me, it’s about both of them.