February 03, 2013
Venture-capital firms are taking stiff measures to survive a tough fundraising environment and lackluster returns, including gutting their partnerships, slashing their fund sizes and refocusing their investment areas.
Take Ignition Partners, for example, formed amid the tech boom in 2000 by several former Microsoft Corp. and McCaw Cellular Communications Inc. executives. While the Seattle venture-capital firm raised around $1.2 billion over the past 12 years, it didn’t produce a consistent string of startup hits. So when it asked investors last year for money for another venture fund, the firm got the cold shoulder.
That prompted Ignition to reboot recently. The firm is shedding seven of its nine investing partners for its next fund. It is cutting the size of the new fund to about $150 million, down from the $400 million fund it last raised in 2007. Ignition also is bringing on a Silicon Valley venture capitalist and will stop investing in consumer technology and telecom, instead focusing solely on business-technology startups.
There were some difficult conversations within Ignition, but “the market challenge was clear,” said John Connors, a former Microsoft chief financial officer who is part of the smaller group at Ignition raising the new fund.
“The marketplace was telling us that smaller [venture] funds are where investors want to be” for potentially stronger returns, added Steve Hooper, a founding Ignition partner who isn’t continuing with the new fund. “Everyone accepted the fact that we needed a much smaller fund.”
Ignition’s revamp is one of many transformations taking place amid a winnowing of the venture-capital industry, which invests in young companies with the aim of profiting later when the startups get sold or go public. Despite a wave of venture-backed initial public offerings such as LinkedIn Corp. and Facebook Inc. over the past two years, the hit investments largely benefited brand-name venture firms such as Greylock Partners and Accel Partners.
For many other venture firms, returns have continued to be relatively weak. For the 10 years ended last September, U.S. venture funds produced a 6.1% return, compared with the Nasdaq Composite Index’s 10.3% increase and the Dow Jones Industrial Average’s 8.6% rise over the same period, according to Cambridge Associates LLC.
As a result, while top venture firms such as New Enterprise Associates have easily raised money, investors are shunning many others. U.S. venture-capital funds garnered $20.3 billion in 2012, essentially flat from 2011 and down from $39 billion in 2007, according to Dow Jones LP Source.
Overall, there were 842 venture-capital firms in the U.S. in 2011 that raised money in the previous eight years, down 16% from 1,004 in 2007, according to the National Venture Capital Association.
Such dynamics are pushing venture firms to reassess and remake themselves. In late 2011, Scale Venture Partners pulled out of investing in health-care companies, citing a tough regulatory environment for the sector, to concentrate on tech investments. Meanwhile, Venrock and Menlo Ventures have reduced the sizes of their funds in recent years and either changed or trimmed back the partners involved.
More venture firms “realize that in order to be successful and deliver returns, they need to be focused on smaller groups of people and smaller sets of companies,” said David Hornik, a venture capitalist at August Capital, which in October closed a $300 million fund, compared with $350 million for its previous fund. Six partners are investing out of the new fund, down from seven for the prior fund, he added.
Many venture firms are responding to a higher bar from investors, who have been disenchanted with scant venture returns and are scrutinizing partnerships closely to pick out the stronger versus weaker venture capitalists in a firm.
Investors “have become more selective because their return requirements are higher.” said Tom Gladden, a partner at investment management firm Adams Street Partners, which invests in venture funds. “We’re going to evaluate the [venture firm’s] team to the point of looking at the personal franchises of individual partners.”
Ignition was launched by Microsoft veterans such as Brad Silverberg and Cameron Myhrvold, and McCaw executives such as Mr. Hooper. The firm snagged marquee tech names, including Microsoft CFO Mr. Connors in 2005, to join its partnership.
But few of Ignition’s investments resulted in Facebook-like returns. Some of Ignition’s longtime startups, such as Seven Networks Inc. and Telecom Transport Management Inc., have yet to generate any profit, said a person familiar with the venture firm.
Ignition found some success was in business-tech investments, including XenSource, which specialized in a technology area known as virtualization and which sold for $500 million in 2007 to Citrix Systems Inc. Last April, Ignition-backed Splunk Inc., which indexes and makes data searchable, went public. According to a person familiar with the firm, Ignition has returned $400 million to its investors since June, largely because of Splunk’s IPO.
Ignition’s Mr. Connors and another partner, Frank Artale, were involved in the Splunk and XenSource deals, through which they met Silicon Valley venture capitalist Nick Sturiale, who also invested in the two companies. Mr. Sturiale invested $8 million in Splunk while at another venture firm, which yielded that firm a more than $500 million return.
Still, Ignition found little traction with investors when it tried raising a new fund in mid-2012. So Messrs. Connors and Artale decided to move forward with a smaller vehicle and bring on Mr. Sturiale.
Ignition’s other partners aren’t leaving the firm immediately, as they manage their existing investments.
Fundraising for Ignition’s new $150 million fund now appears to be going well, said people familiar with the new fund, with investors focused on the track records that Messrs. Connors, Artale and Sturiale had with Splunk and XenSource.
Given the tough venture environment, that Ignition may pull off a smaller fund “is a success story,” said Mel Williams, a partner at TrueBridge Capital Partners, which invests in venture funds.