"SOMETHING VENTURED: Balancing Caution And Excess Cash"
Raymond Hennessey 01/17/2001 Dow Jones News Service
(Copyright (c) 2001, Dow Jones & Company, Inc.) NEW YORK -(Dow Jones)-

Many venture funds won't have to hit the road trying to drum up new capital this year. They'll be too busy trying to more carefully put to work all the capital they raised from new funds in late 1999 and early 2000. "You will find that funds will be more efficient with the money that they already have," said Kevin McQuillan, co-founder and general partner at Charter Growth Capital in Palo Alto, Calif. "You're not going to see a lot of fundraising for a little while." This also means that investors in these funds, spoiled in recent years by quick returns from venture capital, will again have to wait to reap any rewards. In short, the venture capital market is acting as it had been before the go-go era of the late 1990s. In some ways, venture funds find themselves with an embarrassment of riches. Firms are finding that the market slump came just after many new funds had already been raised. In short, venture capitalists have been forced to be more cautious about their investments at a time when they have unprecedented funds in their war chests. First, a little history. As returns were strong for venture-capital investments throughout 1999 and early into 2000, venture funds found themselves in one of the easiest periods to go out and raise new funds. So they did. The result was two-fold: The fundraising cycle shortened dramatically, with new funds being raised roughly a year after firms' previous funds had been closed; and venture capitalists found themselves raising bigger funds than they ever had before. In the first three quarters of 2000, for instance, firms raised $70.2 billion, compared with $59.2 billion raised in all of 1999, according to the National Venture Capital Association in Arlington, Va. At the time, they needed the money. Just as valuations of public companies had soared, so went the value of private companies. In order to take even modest stakes in new ventures, private-equity firms found themselves writing larger checks. Then the bottom fell out of the market. So now, most funds plan to simply stretch out the life of their investing funds. "We used to have a three-, four-, or five-year investment cycle," McQuillan said. "Then that cycle was cut down to a year, year and a half. We're going to see funds going back to traditional norms." Funds do have alternatives, but they're probably unwise, given the volatility in the markets. With more money, funds could simply invest at the same pace that they have been, but choose to take larger stakes in their portfolio companies. For example, a fund that normally would take a 35% stake in a private company might spend more to take a 40% or 45% position. This kind of approach potentially could shut out some other venture capital firms that would normally have made concommitant investments as part of a broader syndicate. In a way, though, this would fly in the face of the new caution many venture firms now profess. "I believe you're going to see more syndication, not less," McQuillan said. "It's just another way to mitigate the risk." Venture funds might also be tempted to put some of their excess cash to work by "moving up the food chain," or investing in different stages of the venture process, said David Chao, managing general partner at DCM -Doll Capital Management in Menlo Park, Calif. A fund that traditionally had been committed to early-stage funding might start taking part in mezzanine rounds. But this has its own set of landmines. "Late-stage investment is a different beast than early stage," Chao said. "The returns are different, the approach is different. Taking a $20 million bet on an early company and taking the same bet later on means different things." Chao, for one, thinks that the lengthening of the investment cycle is not just a byproduct of the newly flush funds, but also of the general approach by venture firms to "get back to the basics." One of the biggest problems for most firms in the past had been that they were making so many investments, they were losing sight of both what they owned and what direction they thought these portfolio companies should take.

In addition to being more cautious with their money, Chao believes venture capitalists will be more careful with the guidance and help they give portfolio-company executives. Funds "will invest in just a handful of companies, and be more involved with them, as they should be," Chao said. "They'll be rolling up their sleeves, helping companies with forming their businesses and making those businesses work."