“Stars are aligned” for new funds

First-time VC funds are entering the US market at the fastest rate since 2001, but could all of the recent activity spell a return to the over saturation of the dotcom boom? Dave Keating reports.

If limited partners are starting to feel like they’re seeing a parade of first-time funds knocking on their door, they may not be imagining things. Statistics for this year thus far show that 2006 has seen a significant shift in where venture capital dollars are flowing, and they’re showing a distinct preference for first-time funds.

According to data compiled by the National Venture Capital Association, 52 firms were founded in the first nine months of this year, compared with just 23 last year. These new firms have raised a total of $4.4 billion (€3.4 billion) from January to September.

“The stars are aligned for new funds,” says NVCA president Mark Heesen. “We’re starting to see limited partners being much more interested in new funds than they have been in the past.”

Mark Heesen, NVCA

Heesen says the increase is due to a variety of factors all converging at once. Part of the reason for this spurt in activity, he says, is the fact that the venture capital industry is approaching the end of its regular business cycle, a time when most of the bigger, more established funds have been tapped out. When this occurs, investors are naturally going to look for first-time funds to take their money.

But aside from the natural business cycle, Heesen says there are larger factors at play here. “From the last fundraising cycle, a lot of firms have drastically cut back the amount they’re raising this time, there aren’t as many billion-dollar funds,” he says. “If you’re not a $3 billion fund, you need a lot fewer partners.”

The assumption used to be that at times like these the departing partners would take the opportunity to work on their golf game or become entrepreneurs themselves. But what’s happened instead is that many of these established VCs are leaving the big firms to start their own. The subsequent funds raised may technically be new, but they’re being managed by seasoned professionals.

They’re realizing that if they want to get into this asset class, they may have to start with newer funds.

Mark Heesen

One such case has been that of Alsop Louie, which is raising its first fund after being formed by former journalist Stewart Alsop and Gilman Louie, formerly a VC with In-Q-Tel.  While Alsop Louie may be a new firm, Louie is a known and trusted face in the LP community. Another example is Contour Venture Partners, founded recently by veterans of Flatiron Partners and Promontory Financial Group.

But Heesen says it’s not just the shrinking size of the largest VC funds that is drawing more managers and more money to first-time funds, it is also a changing attitude among investors.

“They’re realizing that if they want to get into this asset class, they may have to start with newer funds,” he says. “These ‘new funds,’ they’re going to be the new Kleiner Perkins and Sequoias. If you’re loyal to the new funds now, you won’t be getting shut out several funds from now.”

Some LPs have been downright aggressive about seeking out new funds. CalPERS, for instance, has been very public about wanting to look at new funds, saying they believe this is an area that is ripe for very good returns at the end of the period.

With all of this new fund activity there have been some comparisons made to the dotcom period. For his part Heesen says the key difference between now and the bubble is that LPs are much savvier than they used to be.

“I think that the due diligence by the LP community is much more aggressive today than it has ever been in the past,” he says. “They don’t want to be back in the dotcom period where there’s capital going to inexperienced managers. We’re not going to see funds being created and funded that don’t have extremely good people behind them.”