For a New Fund, a Flood of Green ---- Awash in cash, venture capitalists are
creating larger funds, doing more deals and taking bigger stakes. Share the
wealth? Are you kidding?
By Jonathan Rabinovitz, November 05, 1999
Copyright © 1999 The Industry Standard
------------------------------------
The sign hadn't even been hung over the Menlo Park, Calif., office door of
Redpoint Ventures last week when the new firm closed its first fund. Just
three months after opening for business, Redpoint has $600 million to
invest. Redpoint's ability to raise so much money in so short a time is
testimony in part to its sterling team: The firm features the combined Net
expertise of two venture firms now winding down operations, Institutional
Venture Partners and Brentwood Venture Capital. The war chest also reflects
a broader change in the VC business. Throughout the industry, firms are
handling larger amounts than ever before – and investing it in a very
different style. Venture capitalists who used to work as part of broad
investment syndicates are now going it alone. In short, because they have so
much money, they can't afford to share hot deals with others. Because
returns have been so lucrative, firms that used to specialize in early-stage
investments now find themselves looking to invest in later rounds as well.
And the demand of managing so much money has companies adding new partners,
albeit carefully, to speed the money out to the hordes of cash-starved
Internet startups. "The big question is, can you keep doing what we're
doing – investing in early-stage startups – when the funds get this large?"
asks Jeff Brody, a Redpoint managing director. "The answer is yes for us,
but it's new territory." Brody says Internet companies need big bucks
quickly so they can ramp up fast and go public before competition arises.
While he contends Redpoint has the discipline and focus to keep from
overextending itself, he says the excess of easy money may be leading others
to fund deals that shouldn't be funded. The cash is flooding in to VCs from
both institutional investors and wealthy individuals, creating funds much
bigger than those in past years. Redpoint's $600 million fund, for instance,
is double the size of the last fund at Brentwood, which closed a year ago,
and far larger than the $350 million fund IVP closed in the spring of 1998.
And the fund could have been bigger still: Within 24 hours of announcing the
formation of the first Redpoint fund, Brody says, the firm had received
offers for more than $1 billion and had to turn people away. Some investors
who were allowed into the fund were frustrated that they were not permitted
to pour in even more money.
Redpoint's experience is not that unusual. Communication Ventures last week
closed a $250 million fund, twice the size of one it closed last year. Mohr,
Davidow Ventures closed a $300 million fund three months ago, far surpassing
its previous $120 million fund. Highland Capital Partners is aiming to raise
between $400 million to $500 million by January, up from the $250 million
fund it closed in September 1998. Bob Higgins, Highland's managing general
partner, notes that the firm has just added a partner, Keith Benjamin,
formerly of Robertson Stephens, to handle more deals. At the same time,
Highland is putting more dollars into each individual investment. This is
not only a matter of deal inflation; it also goes straight to the nature of
the businesses and the markets they serve. "VCs are no longer backing niche
companies," says Higgins. "That was the venture capital of the 1980s." He
explains, for instance, that today's venture-backed communications companies
immediately begin selling their products and services to Fortune 1000
companies.
But Higgins notes it's also true that individual venture firms are making
larger investments in each deal, in effect trying to produce higher returns
by taking on more of the risk. When Highland-backed eToys did its final
prepublic round, no new investors were added to the mix, he says; the
earlier investors upped their bets. To run its large new fund, Brody says,
Redpoint will rely less on syndication than VCs did a few years ago. The
larger fund also means the firm will invest not just in early-stage
startups, but also in later rounds. Brody calls the approach "life-cycle
financing."
With more capital, VCs who discover promising new companies are more
inclined to make larger bets. Roland Van der Meer, a general partner at
Communication Ventures, recalls a deal in which his firm had done much of
the seed financing. When it came time for mezzanine-level financing, the
firm was able to invest only $4 million of a $30 million round. "We just
gave away $26 million," he says. A larger fund will allow the fund managers
to avoid that predicament. "We want to play deeper and longer," Van der Meer
adds. At the same time that venture funds are getting larger, they're also
repositioning themselves to focus more on the Internet. The formation of
Redpoint, for instance, partially stems from the interest of partners at IVP
and Brentwood to separate themselves from the health-care interests of their
previous companies to invest in dot-com deals.
Communication Ventures has also remade itself, choosing to expand its latest
fund to include e-commerce, as well as telecommunications and Internet
infrastructure. As part of this shift, the firm added a new partner, Michael
Rolnick, formerly a VP of new ventures at E-Trade. In a similar vein,
Bessemer Venture Partners has stopped investing in health care and retail
plays, putting money now in only two areas: e-commerce and communications.
David Cowan, a Bessemer partner, says the firm is putting more money into
each of its investments because of the greater capital requirements of the
new companies. On the other hand, he notes that Bessemer has no plans to
increase the number of deals in which it invests, add more partners or even
to get into later-round investments. While mezzanine investments may yield
greater returns right now than early-stage investments, "market forces will
sooner or later squeeze out the margins that accrue to mezzanine investors,"
Cowan adds. "When the Nasdaq cycles downward, mezzanine investors will feel
a lot more pain than early-stage investors."