Idealab, the founding (&sole) venture investor in IBUY: "Venture Capitalists See Investors Grow
Mutinous
By AMY CORTESE, New York TImes
In March, Battery Ventures, a leading
venture capital firm, held an annual
meeting in a Florida resort for its limited
partners, which include some of the biggest
pension funds and endowments.
A moment of levity came when Thomas J.
Crotty, a Battery executive, awarded a
trophy to a limited partner who had won a
golf tournament. As he presented the cup, a
cheap $100 job, Mr. Crotty said it showed
"just how desperate V.C.'s are to give
anything to a limited partner these days."
The remark drew laughs, but it also reflected
the escalating tension between venture
capitalists and their investors. In the two
years since the Internet bubble burst,
venture investors have watched their lush
profits shrivel. Yet many venture capitalists
are still doing quite well for themselves
because of the large management fees they
collect from investors. Fees are based on
their funds' size, so as funds ballooned over
the last few years — about 40 have at least
$1 billion in capital — so have the fees.
With typical fees at 2 to 3 percent of a fund,
a venture capital firm with a $1 billion fund
would collect $20 million to $30 million
annually from investors, even if only a small
amount of the fund has been invested — and
into money-losing companies at that.
The incongruence is at the heart of a brewing investor rebellion. While limited
partners have little legal recourse, many are demanding more information and
pushing venture capitalists to make changes, like reducing the size of funds
and, therefore, the fees. At least five big firms have scaled back funds this
year.
"Limited partners have gone from sullen to mutinous," said Howard
Anderson, the senior managing director of YankeeTek Ventures, a venture
capital firm in Cambridge, Mass. "What's driving them nuts is that the venture
partnerships do well in bad years. If rewards are shared, the pain should be
shared, too."
Those tensions have boiled over at some of this season's annual meetings,
which began in February but hit full stride this month. They are the one time
when venture capitalists formally address all of their investors, and are usually
polite affairs where criticism, if any, is reserved. But with the bulk of meetings
still to come, venture capitalists are bracing for the worst.
"The limited-partner community is scared, angry and in a mood to be more
challenging of their money managers," Mr. Crotty said. Although Battery's
performance is better than many, he said, "we weren't sure what kind of
audience we were going to face."
Mr. Crotty's colleague, Anthony Abate, put it more colorfully: "We thought
they were going to storm the Bastille."
Battery's meeting went better than its investment leaders had expected, they
said, partly because they spoke frankly and tried to answer all questions. But
meetings at some other firms have been strained.
The annual meeting of Redpoint Ventures of Menlo Park, Calif., was held in
February at a nearby hotel. People at the meeting said one investor stood up
and challenged the firm's capacity to invest its $1.25 billion fund prudently.
Redpoint partners offered their rationale but, according to one attendee, "the
dogs weren't eating the dog food." A month later, Redpoint reduced its fund
size by 25 percent.
The most uncomfortable standoff may have been at the meeting of Idealab,
the technology incubator, held in March in Pasadena, Calif. The firm has
been sued by investors including Dell Computer and Moore Global
Investments, who have accused Bill Gross, its founder, of mismanagement.
Mr. Gross is fighting the suit.
The meeting was contentious from the start. Idealab insisted that a court
reporter, brought in by some aggrieved investors, leave the meeting. The firm
distributed rules of conduct for the meeting, stating that it could stop
discussions that exceeded two minutes, used derogatory references or
concerned confidential information related to the lawsuit.
Presentations by Marcia Goodstein, who is the president and chief operating
officer and Mr. Gross's fiancée, and by a director, Robert Kavner, a former
executive vice president at AT&T, were among those prompting pointed
questions, according to two people who attended. Idealab said it invested
about $1 million a month but spent twice that much a month to operate its
fledgling companies. The largest operating expense, it disclosed, goes to
salary and benefits: Mr. Gross's compensation, including salary and bonus,
exceeded $750,000 in 2002, up from $250,000 in 2000. During that same
period, the plaintiffs charge, Idealab lost half their $1 billion investment.
Idealab says some of the money was invested in companies that are still
going concerns. Several investors walked out early.
The mood is a far cry from that of the late 1990's, when the meetings were
more like lovefests and investors didn't care to hear the details because the
cash was flowing in.
"Limited partners are forcing the general partners to go back and rethink
whether they can invest their money within a reasonable amount of time,"
said Jonathan Axelrad, a lawyer at Wilson Sonsini Goodrich & Rosati, a law
firm that represents technology companies. "This is a unique set of
circumstances the venture industry has not faced before. People are casting
about for creative solutions."
That partly explains the fund-cutting in the venture world. Some prominent
firms, like Mohr, Davidow Ventures and Kleiner Perkins Caufield Byers,
have voluntarily reduced size and averted investor criticism. "If you see this
palace revolt coming, maybe you head it off and take some action," Mr.
Anderson of YankeeTek said.
The cuts have pressured other venture capitalists to trim funds or split them
up. Fund size is "an area of significant concern to limited partners, and
properly so," said Alan Austin, chief operating officer at Accel Partners,
which has proposed splitting its $1 billion fund into two. That would reduce
some management fees but still lock up investors' capital. It is unclear if
Accel investors, who voted on the change by mail, have approved it; results
will be tallied in time for annual meeting on April 25. If it is defeated, the
meeting "could be a real food fight," one investor said.
Few regulations cover what venture capital firms must disclose, and the level
of information they provide to their investors varies widely. Some gloss over
details at their meetings, but that approach is not going over well this year.
To some extent, the funds are feeling the same pressures for openness that
has roiled the broader investing world since the collapse of Enron.
Battery Ventures spent months preparing for its meeting, where it dissected
the firm's performance, good and bad. It detailed write-downs and write-offs
and went over a "watch list" of troubled investments. (Three were shut down,
three received more financing and one was sold for $350 million.) Battery
also told investors that the 2001 revenue of its 27 portfolio companies was
$275 million less than it had forecast.
From an investor's point of view, such transparency is helpful in difficult
times.
"We want as much information as possible," said Richard J. Hayes, a senior
investment officer at Calpers, the huge pension fund. "Most of our partners
are getting into the nitty-gritty details of their investments. That's what we
want." |
