Brian Berliner’s Brain

Sevin Rosen Funds have announced that they will not close a planned $300M Fund X this month after all. The NY Times wrote a nice piece on the story and there have been multiple blogosphere posts on the matter, which I will cover in great detail below.

I recently spent 10 months with the Sevin Rosen Funds team as an EIR. They granted me 100% transparency into their business and decision making processes. They allowed me to attend all Monday Partner meetings, two LP Annual Meetings, multiple offsite planning and portfolio review sessions, bring in dealflow, and assist with due diligence activities. I have a ton of respect for the team and feel very privileged to have had the opportunity to work with and learn from their many years in the Venture Capital industry.

Pictured above is Steve Dow and John Jaggers. In my time with Sevin Rosen, I was particularly impressed by these two gentlemen — due in no small part to their significant careers with Sevin Rosen Funds (Steve started with SRF in 1983 while Jaggers started in 1988). Steve represents the front-office deal-making (entrepreneur) side of the house and is excellent at many things, including listening to a pitch and cutting to the heart of the matter in very concise and succinct language. Jaggers represents the back-office fund-making (LP) side of the house and is absolutely rock-solid both in his understanding of fund accounting and management, but also with his view of prospective portfolio companies. When Jaggers makes a comment, you’d better be listening, because he’s right. Now, to be fair, I’m probably only saying that because I always shared his viewpoint :-). These two guys make a really great team.

Bottom Line: While Steve is the one talking to the press about all of this, you can bet that Jaggers is back there taking care of business with the LPs and is just as much a key part of the decision to stop the fundraising activities for Fund X.

One of the things I really liked about Sevin Rosen Funds was that, as a firm, they have a moral compass.

I point that out because not every firm in the VC community does.

The SRF team enjoys taking the contrarian view. Being a contrarian can certainly pay off if the timing works out in your favor. VC is a timing business. VC is also a hits business. Sometimes the contrarian view timing hits and sometimes it doesn’t. It’s easy to be a Monday Morning Quarterback on this stuff — anyone can do that.

One could argue that the last 9 years of contrarian bets placed by Sevin Rosen Funds has not reaped the rewards that anyone wanted (betting big on telecom and largely avoiding the Web 1.0 Internet boom, followed by great weakness in telecom during the bust). Paul Kedrosky in Sevin Rosen: Venture Capital is Over says:

Critics will say that SR’s best days are past, and this is more about pining for the days of yore. To that way of thinking, this could even be taken as a contrarian signal for venture, with a branded firm out of step with its market and its LPs. After all, most of SR’s highest returns were relatively long ago, so this could certainly be viewed as simply spinning a bad situation.

Well, VC is certainly a “What have you done for me lately” industry. One could make the case that Sevin Rosen Funds has not produced a big hit of late. Why is that? Lots of reasons, I’m sure. SRF, and the VC industry, has seen significantly more change in the last 9 years than it saw during SRF’s first 16 years — the pendulum is swinging faster than ever and it may be harder to spot the best contrarian investments in an environment where the exits cannot materialize in a timely fashion. I don’t know. I do know that Steve and Jaggers are very introspective and are working it out. The question will be whether SRF can adapt and find a way to be more nimble.

But, why put a stop to Fund X in the final hour? Most VC firms would have taken the money, stacked the fees up on top of Fund IX, and worried about returns later feeling comfortable with the fact that the LPs understood the risks inherent with investing in the Venture Capital asset class.

Actually, I commend SRF for backing out of the commitments if they felt like they did not have a formula to give their LPs a solid return in the current environment. We’re back to that moral compass thing.

Frankly, I was surprised that SRF attempted to raise Fund X this calendar year. When I finished my time with Sevin Rosen Funds at the end of February 2006, the message communicated to me was that Fund X would likely be raised in the second half of 2007. That sounded about right to me, since Fund IX was a $305M fund that started being invested at the end of 2004 with a slower investment cycle. When I attended their Annual LP Meeting in May 2006, Jaggers communicated that Fund X would be closed this October. Surprising, but not out of whack. Kedrosky covered it in Sevin Rosen’s Retooling. Multiple smaller funds is not fundamentally different than one larger fund, but does give the firm the ability to be more agile in their approach to the markets and focus of a particular fund (at the expense of more fund raising time and more frequent LP communications — not necessarily bad things).

Fred Wilson in Is The “Traditional Venture Capital Model” Broken? comments on Steve Dow’s statement that “The traditional venture model seems to us to be broken,”. Fred responds:

So we need a new approach to the kind of companies we fund and we need a new approach to how we fund them and how we get out of them. I don’t see that as a “broken model”, just a model that we need to tweak. The answers are pretty obvious actually.

We’ve got to raise smaller funds.
We’ve got to do less “hard tech” and more “soft tech”
We’ve got to figure out how to make great returns on $100mm to $250mm exits
We’ve got to limit our IPOs to our very best companies

I would agree that the “traditional” model is broken — back to my comment about the amount of change the VC industry has seen in just the last 10 years. But, VC is not broken. VC is a marketplace and firms need to adapt as the environment changes. The environment is just changing really fast now.

I disagree with Dow on another point. There is never “Too much money”. There is exactly as much money as the LP community is willing to put at risk. Yes, more money does make VCs have to compete harder for the best deals. Yes, the lack of strong M&A and IPO exits puts a bigger strain on the asset class as a whole. But, at the end of the day, the exits are absolutely there for the best portfolio companies, found and nurtured by the best VC firms which are funded by the best LPs. That is the VC marketplace. Evolution is at work. Competition and coopetition, and partnering for survival are all part of the mix. VC firms need new blood with motivated GPs willing to earn their keep based on carry, not fees.

My buddy Peter Rip adds to the conversation in Venture Capital 2.0: It’s All A Game with a nod to the Prisoner’s Dilemma and game theory which struck a chord with me (I’m currently reading the book Thinking Strategically). Peter also contributed a nice article to VentureBeat in Venture Capital 2.0 - the evidence accumulates.

Stowe Boyd in Traditional VC Model: Broken, or Just Tired? says:

I have been working as an “advisory capitalist” for some time — working as a strategic consultant with social tool startups, and guiding product design and development with them — and continue to be struck that VCs are not getting involved in providing advice to these startups, prior to funding. I bet that in the future, more VC firms will have people like me on board, working on an advisory basis with early startups, and then bringing the best of the bunch into a funding event to help those companies expand.

Like Boyd, I am also an Advisor Capitalist and agree that the best VCs will need to move to earlier stage investing for the best returns. What’s interesting about this comment is that Sevin Rosen Funds has always been very much focused on early stage investing, including doing lots of seed and “incubation” deals. This was something that really impressed me about those guys. So, I think their model is right for the times (though they will need to adjust their segments), but Boyd raises an interesting question — are they tired? Kedrosky points out that “Fund VII and Fund VIII apparently delivered -27% and -13% IRRs, respectively.” Negative IRR means no carry. That’s a long time for a VC to go without putting serious dollars into their checkbooks, and can contribute to them being tired. They may need fresh blood.

The Deal’s VC Ratings in Sevin Rosen’s capitulation is not indicative of VC industry problems says:

Sevin Rosen’s exit is precipitated by a poor succession strategy and a failure to adapt to a new venture capital climate that now rewards international bets, a mix of a young and old partners and segment specialization. Oh yeah, its mediocre returns didn’t help the firm’s case.

Fair observations. Combine my earlier comment on “no carry” with this comment on succession strategy and you have an interesting mix. While I was working for SRF, they parted company with General Partner Dave Shrigley and Partners Kevin Jacques and Amra Tareen. SRF had way too many investment professionals when i started with them (upwards of 14) for the size of their most recent fund (Fund IX at $305M), so this downsizing is not surprising. Dan Primack writes today in PE Week Wire that GP Steve Domenik has announced his intention to leave as well (something that I had not heard before today). Again, all necessary for a firm focused on smaller fund sizes. I will not comment on other potential successions, but I would certainly expect to see more movement in the ranks.

Then, VC Ratings turns a bit harsh:

Despite Sevin Rosen’s claims, there are few lessons from this fundraising failure that should be applied to the entire venture capital industry. This is about one firm’s inability to succeed without its founders. It’s about a firm’s unwillingness to believe in new technology movements such as the Internet. What it’s not about is the venture capital model being broken.

Followed closely by more harshness from Charlie O’Donnell in Hardware Veterans Retire… Death of Web Investment Prognosticated:

Sure, there are a lot of problems people can point to in the venture market, but these guys aren’t even playing in the same world as the VCs that get talked about in the blogosphere for their high profile internet service investments. They’re a bunch of hardware guys whose very long and successful careers, like the infrastructure opportunities they chased, are winding down. They’ve made a lot of money, and rather than try and figure out how to build the next Google, Skype, YouTube, they’re letting another generation tackle a new generation of completely different opportunities.

Having been on the inside with SRF, I would have to disagree with those comments. Charlie describes it as if Sevin Rosen is going away. That’s just flat out wrong. SRF is a good, solid brand with excellent LP relationships (thanks Jaggers). They may choose to redefine themselves, but they are not going away.

Finally, Matt Marshall of VentureBeat in Venture shocker: Sevin Rosen returns cash, cites “terrible” environment says:

Dow agrees there are lots of attractive areas to invest, from clean technology, to biotech, nanotech and personal health — more places than there were two decades ago. But that doesn’t mean you can make good profits from the investments, he said. In the letter, the firm wrote that the last year of fund-raising that the entire industry saw positive results was 1997. (Those funds were invested in 1998 and 1999, and saw great profits during the last part of the boom).

I don’t get the need to cite when the VC industry as a whole last saw positive results. The statement may, indeed, be true, but I don’t think it matters. We’re back to my earlier comment about VC being a marketplace. The LPs really just care about the returns of the fund. The returns of the firm. The LPs distinguish themselves by the firms and funds that they invest in and love it when they get top-tier returns even when the overall asset class is underwater. Focusing on the VC industry might be the best thing for the betterment of the industry, but might not be the best thing for the betterment of the firm.

So, yes I highly commend SRF for doing the right thing and not closing Fund X now.

However, I don’t get the reason.

I do not think that the reason was spin. I completely believe that Sevin Rosen could have closed a $300M-ish sized fund right now if they wanted to. If the VC industry was broken, it was surely broken a few months ago when they started the process of raising the new fund. And, they would have known it then and would have delayed fundraising. If they are right that the exit opportunities are not there for closing a fund now, then that can’t be good news for their current fund, Fund IX, closed 2 years ago, which will be at the end of its investment period within 12 months.

As I mentioned above, I don’t think it’s that VC is broken. It may be that Sevin Rosen is no longer competitive with the top-tier firms (whoever they are today) and it is better to sit it out and retool for top-tier results than it would be to play, take the fees, and risk not being in the top-tier. I would certainly agree with that logic and strategy. Go dark, regroup, recharge, and come out of the gate running.

Steve Dow ends with: “We have properly diagnosed the problem, but haven’t figured out for this patient what the therapy is.” Now, that, does sound like Steve!

To Sevin Rosen Funds: Thanks for doing the right thing, which was certainly harder than just taking the money.

Tags: Sevin Rosen Funds, SRF, Sevin Rosen, VC, Venture Capital, funds, Brian Berliner, brianberliner