Climbing out of the bust
Venture funds must work hard to recapture returns of the past. Be patient, they say
By Lori Hawkins
Monday, August 4, 2003
Venture capital funds are still reeling from the bursting of the tech bubble nearly three years ago.
Funds raised in the past five years are awash in red ink, and venture capitalists are going to have to hustle to get returns up to the high levels of the past.
Average returns so far for funds started between 1999 and 2001 range from -13 percent to -33 percent, according to new data from the University of Texas Investment Management Co., which manages endowments for UT and the Texas A&M systems. It recently began disclosing information about its investments because they are made with public money.
Compare that with returns from pre-boom funds raised between 1995 and 1997 that averaged 20 percent to 36 percent gains, and it's clear venture capitalists have their work cut out for them.
The past three funds raised by Austin Ventures, the country's fifth-largest venture firm, are in the red right now -- like nearly everyone else in the industry.
The estimated return so far on Austin Ventures' 1998 fund stands at -16 percent, according to UTIMCO data. Its 1999 fund is at -25 percent, and its 2001 fund is at -33 percent.
A fund raised in 2000 by Austin-based JatoTech Ventures is down 46 percent.
The story is the same in Silicon Valley, with funds raised in 2000 by Kleiner Perkins Caufield & Byers at -15 percent, Sequoia Capital at -19 percent, Matrix Partners at -30 percent, Accel Partners at -22 percent, Morgenthaler Ventures at -27 percent and Oak Investment Partners at -28 percent, according to the most recent data from the University of Michigan's venture investments.
However, venture capitalists note that current returns on funds such as these, which haven't been fully invested, are artificially low because of front-weighted management fees.
"Industrywide, '99 and '00 vintage funds will be the worst in the history of the venture business," John Thornton, an Austin Ventures general partner, said via e-mail. "Our investors are pretty unified in that perspective, and most of them have been in (venture investing) for a long time.
"We're confident that our returns in those funds will be better than most, but there's a ton of heavy lifting still required to make that happen. That's just the nature of our work."
The reality might not be as grim as the data suggest right now. The funds aren't fully invested and have many more years to realize returns through sales or public offerings of companies in the portfolio.
(Venture capital funds are measured by what's called an internal rate of return, a complex formula that focuses on money flowing in and out of a fund, rather than just the amount of money returned to investors during the average 10-year life of a fund. They also aren't actual returns but generally what venture capitalists estimate their investments might be worth today if they were sold.)
Though Austin Ventures' 1998 fund is 95 percent invested, the 1999 fund is just 60 percent invested, according to UTIMCO data. The 2001 fund is just 19 percent invested.
"The key word here is patience, and investors in venture funds know that," said Kirk Walden, national director of venture capital research for the PricewaterhouseCoopers accounting firm. "Austin Ventures has a lot of money left to invest, and the companies they're investing in need time to perform. It's simply too soon to judge them."
Time and luck -- key ingredients in venture investing -- are powerful allies.
"What you have to remember is it only takes one hit" to generate huge returns and transform an anemic fund into a star, said Michael Kelly, managing director of Hamilton Lane, a Philadelphia-based money manager and adviser to institutional investors in Austin Ventures.
A single home run -- Tivoli Systems -- helped catapult Austin Ventures into the big leagues when Tivoli went public in 1995. Austin Ventures received an estimated $80 million for its $2.5 million investment in the Austin software company.
Austin Ventures scored again in 2000, when Silicon Laboratories Inc. went public, which helped fuel the amazing results of its 1994 Fund IV. The fund posted a 73 percent average return, according to UTIMCO data. Other funds in which UTIMCO invested that started in the same year returned an average of 47 percent, and the national average was 21 percent, according to research firm Thomson Venture Economics.
Investors in the 1994 fund still marvel at the return: $8 for every $1 they put in.
Thornton notes, however, that the fund also shows why early results are a poor predictor of ultimate returns.
It "did not start out as a strong fund at all," he said. "In contrast, (our 1999 fund), which is from what everyone now realizes is a far more challenging vintage, showed very strong early returns."
The 1994 fund helped Austin Ventures, which launched its eighth fund two years ago, earn a reputation as a top-tier firm in the 1990s. Its 1996 fund recorded a 38 percent return, returning $2 for every $1 invested by UTIMCO.
Bob Boldt, chief executive of UTIMCO, said the returns during the boom were a one-time phenomenon.
"We were scratching our heads back then and thinking, `This can't last.' "
UTIMCO remains a fan of venture capital. Since 1988, UTIMCO's venture investments have earned a 14 percent average annual return, compared with about 8 percent for stock investments in the Standard & Poor's 500 index.
A different world
But the venture world has changed drastically since Austin Ventures raised the money it is now investing.
When its three most recent funds were raised in 1998, 1999 and 2001, venture capitalists couldn't put money into Internet companies fast enough. The edict from investors -- primarily large institutions, pension funds and endowments -- was to pump huge amounts of money into risky technology startups, and, in turn, to reap huge amounts when the companies went public.
That model crashed with the IPO market in 2001.
"Everyone had to step back and say, `Who are we? What do we have to do to survive?' " said Kelly of money manager Hamilton Lane.
Austin Ventures, like many others, largely retreated from doing new deals to focus on salvaging existing investments. Much of its time was spent closing some companies, folding some companies into others and putting additional money into the survivors to keep them alive. It also reorganized its staff, trimming the number of partners. "The last couple years were great times to put money to work, and we were a little frustrated that it wasn't happening," Kelly said. When venture capitalists hold back, we get pounded on by our clients who say, `What's going on? We gave you this money to have it invested.' "
Austin Ventures and other large venture firms cut back the size of their most recent funds launched during the boom as valuations, or the amount investors paid for stakes in young companies, fell sharply. It cut the size of its 2001 fund from $1.3 billion to $830 million.
Since then, Austin Ventures has turned its attention back to new deals. During the first six months of 2003, it has invested $100 million, up from $60 million in the same period a year ago.
Its 28 deals during the first half of the year made it the third most active venture firm in the country, according to the PricewaterhouseCoopers MoneyTree survey.
"Some of our best investments were made in the worst of times," said Joe Aragona, a general partner at Austin Ventures. "If you're in this business for the long term, you can't pick and choose when you invest."
Austin Ventures is putting money into startups, such as Austin computer hardware developer Conformative Systems Inc., and more established technology companies, such as security-device maker NetBotz Inc.
It also is returning to its roots by doing buyouts, which allow it to put a large amount of money to work quickly and with less risk. Last month it bought Staktek Corp., an Austin company that makes computer memory products, for $100 million.
During the dot-com-fueled tech boom, 80 percent to 90 percent of Austin Ventures' investments involved young, high-tech companies in Texas. Thornton says that will probably drop to between 60 percent and 70 percent, as it was before the boom.
"This means slightly -- but not radically -- more activity in companies which are more mature, outside the region and not necessarily hard-core technology plays," he said.