PureVC

Congratulations SkyBridge Capital!

I wanted to take a moment to congratulate Anthony Scaramucci and Andy Klein on the closing of their new fund, SkyBridge Capital. As announced by Reuters, SkyBridge closed on $330 mm with backing by Michael Dell's investment arm, MSD Capital. The strategy of the fund is to seed hedge fund startups with strong managers who are looking to start their own gigs. As I mentioned previously, I am an investor in the deal so I am bound to be hush hush on the details.

At any rate, SkyBridge has announced their first two investments, Westport Capital Partners and Brompton Cross Capital Advisers. Westport Capital will focus on real estate assets and will be run by a heavy hitter from Oaktree Capital. Brompton Cross will focus on technology, media, and telecommunications and will be run by a guy branching off of the legendary SAC Capital.

The folks at SkyBridge have done a great job putting their company together over the last year. They have a group of major league fundraisers on staff with some deep connections all over the world. In working with some of the people at SkyBridge over the years, what impresses me most is that their management strategy is responsible and conservative. They manage their companies as if they were already public companies. Time and time again they stick to their timeline and do not set high of expectations. They then consistently deliver ahead of schedule, which makes everyone happy!

Good work Anthony and Andy and good luck on this endeavor!

The VC Who Has No Money

Fred Wilson has commented on a post by Stowe Boyd on Advisory Capital. It's a great post and there seem to be a lot of comments by people who do what Stowe does but have never called it "Advisory Capital". While I applaud Stowe for eloquently describing something he calls "Advisory Capital," the truth is that this is exactly what Venture Capitalists do and have been doing for quite some time. I often help out companies for equity without putting in cash. I like to refer to this model as the "Venture Capitalist Who Has No Money". After all, without capital to invest, how can you gain equity? You must provide something of value and that happens to be advice and connections.

There are a host of people in the business community that provide advice, guidance, or stewardship to companies of all sizes in exchange for equity. This can range from the venture capitalist, angel investor, token board member, service provider, contractor, family or friend. Basically, anybody that helps out a company that would normally get paid in cash can always opt to get paid in equity. When the climate for new issues and startup companies is hot, everybody jumps on this bandwagon and would rather get paid in equity. Down the road, when the tide turns, nobody wants stock, everybody wants cash.

Can the VC who does invest money provide "Advisory Capital"? A VC who is involved at the earlier stages of a company has the opportunity to provide advice in exchange for equity. Many early stage VCs provide "Advisory Capital" through their incubation practices and their Entrepreneurs in Residence. When the deal is too small for the managed money pool, it is not uncommon for the GP to help a fledgling startup out in exchange for equity, then when the startup gains momentum, to come in with a chunk of managed money.

What about a middle stage or later-stage VC? How can he provide "Advisory Capital"? Well, when a company is more than just a fledgling startup, it is unusual to see "Advisory Capital" exchanged for equity. The reason that you don't see the doling out of equity at later stages of a company in exchange for advice is that at that stage there are people who are putting up hard cash for equity. It won't sit well with them if the company is giving out equity at the same time in exchange for "advisory services."

I submit that a VC who has invested money in the deal is also getting equity in exchange for his advice. When the venture cycle is down, most good VCs will provide advice, guidance, and expertise rather than more capital. If a VC has invested in a company and at some point is giving advice, then he is not just providing capital into the deal. He may not get separate equity for the "Advisory" Component of his role with the company, but it is very likely that he has driven a hard bargain on valuation and that in some sense, the smaller valuation or "better deal" on his capital investment is his equity for his "Advisory Capital" After all, why would a startup allow itself to be slighly undervalued in exchange for capital, unless that VC is providing more than capital?!?

Will Advisory Capital be the new model of Venture Capital? Will Advisory Capital replace traditional Venture Capital? I agree with Fred that you must have "skin in the game" and hard cash in the game to really be a part of the venture. However, I submit that a good Venture Capitalist will provide whatever needed to help his company grow and thrive. In the early stages, this may be advice or guidance, in the later stages this may be capital only. Call it "Advisory Capital" or "Venture Capital" or whatever you want, the bottom line is that this person is helping a company succeed and is getting equity or a better deal on his equity investment for doing so.

VC Primer: Fund of Funds

So the question I have received from several readers is this - which is better, investing in a Fund of Funds (FOF) or Direct investment into a private equity fund? Let me first insert a disclaimer here saying that I do not provide investment advice and will not be legally liable for investment decisions of my readers. I also should disclose that I advise a firm, CXO Private Equity, which is affiliated with my venture investing group, and we offer FOF to investors with low minimums. So anything I say here is not a solicitation for investment, it is coming from an investor who personally invests in FOF as well as in private equity funds.

So what exactly is a Fund of Funds? Well it is pretty simple - it is a private equity fund that invests in other private equity funds.

FOF exist is all shapes and sizes as well as different mixes of private equity classes. Traditionally, a large FOF will have allocations to VC, Buyout, and perhaps some Direct Portfolio investments. The exact mix of these funds largely has to do with the flavor of private equity that is hot at the time. For instance, in the go go days of 1999 & 2000 most FOF were heavy on the VC side, while current FOF launches are actually marketing their "buyout heavy" allocation.

So what are the pros and cons of FOFs? There are two words that come to mind when thinking of the Pros of FOF - ACCESS & DUE DILIGENCE. Like most of private equity, ACCESS is key. You can't get into in a Carlyle, Blackstone, Silver Lake, or GTCR Golder Rauner fund by calling over and asking for a PPM. You generally have to have a connection to someone in the buyout industry or someone at an I-bank doing a placement for that fund. You also have to bring the CHEESE - most minimums for buyouts will be around 5 to 10 mm, particularly for new investors. It might seem unfair that you have to "pay to play" to initiate an investment relationship, while more established investors are not subject to the minimum. But you have to understand that the lifeblood of private equity is relationships in dealmaking, among dealmakers, and among funds and their investors. When a firm has a bad fund, they fully expect that their loyal investor base will come back and support them again. So a firm will always prefer old, loyal investors that they know, over new, potentially litigious investors.

Now the second Pro is DUE DILIGENCE - you simply cannot find out information about which funds are performing in what quartile for any given year. The world of private equity is hush hush. Yes you can go out and buy a book that claims to have tables showing quartile performance for all funds in given vintage years, but the acquisition and dissemination of this data is highly inefficient. Performance reports often lag several quarters. Even among those that are required to disclose to public investors, there is discrepancy among reported IRRs and returns to investors. So a good firm that offers FOF will have done extensive due diligence on investment partnerships and the performance of their funds over several cycles. This concept of due diligence is perhaps even more important than access. After all, who wants access to a fund that will not perform?

Now for the Cons - well actually there is one major con - a FOF charges its own layer of fees. This is usually between 1 and 2 percent per year plus a 5 percent carry. Is it worth paying this extra layer of fees? Well, if you have 100 mm in the bank then probably not, you could probably get access to some great funds. If you don't have that kind of cheese, then I do think it is worth it because you get access to great funds that most people will not. The fees from a FOF are pretty nominal, and the outsized gains in private equity easily eclipse these fees. In general, if your FOF didn't return well, it is not because of the layer of fees, it is because of the underperformance of the funds within the FOF.

Some of the minor cons include the inability to manage the distributions of the fund and the lack of choice of the investments. If you are a direct investor, when the fund distributes monies, you get it when they distribute. If you are in a FOF, the FOF usually controls when you get the distribution. Similarly, if you are in a FOF, you may not get to pick which funds are in the FOF. Sometimes, when the FOF is fundraising, it does not even have firm commitments, but only a "pipeline" of potential funds.

In conclusion, I like both FOF and direct investments. I have investments in both. I generally use FOF to gain exposure to European funds as I do not have an extensive European private equity network.

I look forward to your questions or comments. If you are one of my readers and are affiliated with a firm in the US or internationally, please feel free to drop me a line as I am always trying to initiate new private equity relationships.

SIPphone gets VC funding

As reported by Ed Sim of Dawntreader Ventures and The Gizmo Project Journal,  SIPphone has received $6 mm in funding. For those of you who don't know about SIPphone and their Gizmo, I have previously posted on the battle between Gizmo and Skype. While I was an early adopter of Skype, I have switched to SIPphone and Gizmo because I believe in the philosophy of the open network. Some people at AlwaysOn Network have endorsed Skype as one of the best technology companies, despite the fact that Skype is a closed network. I am surprised at this endorsement, but the folks at AlwaysOn claim that Skype is virtually an open network because it is available to everyone in the world. I don't agree and my feeling is that the open network will go where the industry goes, while the closed network risks being left behind as the industry changes.

Interestingly, Ed has mentioned in his post that their investment does not signal a "zero sum" game between it and other VOIP/IM players (read Skype), rather a battle between VOIP/IM/emerging digital technology and incumbent telephony companies. While I agree that the incumbent telephony companies are running scared, there will inevitably be a battle between the closed and open networks. Coincidentally, Skype has upped the ante on VOIP by recently announcing the upcoming availability of Skype on mobile networks.

I can't wait to see how it all plays out and I look forward to how both SIPphone's Gizmo and Skype transform the industry. Despite my preference for Gizmo I can be reached on either with the handle cxoventures.

VC Primer: The Carry

I have been waiting for something interesting in the news before I posted for the first time about buyouts. The Deal has reported an interesting story about Bain Capital and its 30% carry being a contentious issue with LPs during its fundraising. So my first post about buyouts happens to be a great VC Primer as well - The Carry.

What exactly is “The Carry”? This is the percentage charged as an incentive fee on profits. Some people refer to it as the “incentive allocation”. What it amounts to is the percentage of the profit that goes to the fund managers. Given the potential for outsized gains in the venture and buyout category, the carry necessarily incentivizes the general partners to go for big wins.

Typically the carry should vary appropriately to the quality of the fund. I have seen carries as high as 40% on a superstar fund and as low as a few percent on a fund of funds. There used to be a general rule that if you were an investor looking for funds, typically to stay away from funds with a lower carry. The standard ranges from 20 to 30 percent but this can also vary by the demand of “access” into the fund. In the go go days of the internet boom, there were several first time funds with hefty carries. In contrast, in recent years the carry has been more reasonable. I personally think it is silly to evaluate a fund based on the carry but then again the carry usually is associated with past performance.

Now for a buyout fund the industry standard is 20%. The issue being raised by some of Bain Capital's LPs is that a 30% carry is unjustified for a few reasons. First, everyone else is charging 20%. Second, many of Bain's deals are club deals in which other firms are coinvesting. Those other firms are charging a 20% carry for essentially the same investment as Bain. Apparently Bain has felt the need to justify their carry based on their track record and large research staff through a letter to investors.

A crude example of a 20% carry on a $10 million commitment to a fund where the total capital commitment was called would be that once the investor is paid back his original $10 mm the rest of the profits are split 80% to the investor and 20% to the fund. If the fund makes 3x on its fund then the carry would amount to $4 mm paid by the investor. If you imagine that the carry is paid by every investor, you can see how lucrative it can be for the fund to have big wins.

Now, the above example is simplified. There is usually a “hurdle” or “preferred return” involved. Also, the fund will charge a management fee as well. I will post on these two topics later. What I will say for now is that I don't believe in the hurdle, I don't believe in high management fees, but I do believe in substantial carries. The venture investor should get paid for large gains and the best incentive is to get paid from the back end proceeds rather than upfront or along the way.

Venture Capital - The Entrepreneur's Perspective

Tom Evslin has started a great series called "VC Primer from an Entrepreneur's POV" with an awesome post about "Source of Funds". It is refreshing to see this from an entrepreneur's point of view. I generally agree with most of the points he has written about. There are several points that could be whole posts on their own and I hope he takes the time to address them. I have written about a few of these points in my nascent series "VC Primer". As I alluded to previously in my post, "Fundraising and Blue Sky Laws" - it is important to know who the VCs are and what their VC lineage may be.

Tom brings up excellent points about the necessity to really get your finger on the pulse of the VC firm and to discover any intra-firm dynamics that might affect how the VC will behave in the investment. Some more subtle points that he hasn't mentioned include:

-Knowing how the various partners of the firm are compensated, not just the management fees and carry from the fund, but how these are distributed to the fund partners and associates. I have posted on this in Partnership Compensation. In general you want to have someone who is motivated, forward-thinking, and enthusiastic about your investment. In some cases this might be the younger partner/associate who would like to make a name for himself and who will work overtime to help your business succeed, versus the more established partner who may be out playing golf half the time. Similarly, you need to know who in the firm really can add value through their experience and connections.

-Knowing about the fund and other portfolio companies. Tom touches on this issue a bit, but in general you want to know the characteristics of the fund that is investing. How big is it? What are the other investments like in terms of size, stage, maturity, and likelihood of success? VC's are risk takers but also like to hedge their bets and roughly estimate which companies in their funds will need further resources. If you are taking money from a fund that has several other self-sustaining winners, then you are golden. If your other portfolio brethren are draining cash away from the mother ship fund, then know that the hand that feeds you might someday turn you away.

-Know about the other funds within the firm. There are many dynamics that can create conflict within a firm's funds. I have written briefly about this before here. This somewhat overlaps to previous issues, but in general if you are in a fund that needs to make money because it is new or the firm is coming off a bad fund, this will dictate how the partners treat the investment. They may have learned their lesson from their last fund and be quick to shut off the money pipe, or they may be more patient this time around. If you know that their previous funds were winner and losers and you can figure out why, then you will know what types of companies the VC does the best with, and this can help guide whether to take funding. Remember, it is not just about money.

I have plenty more to say on this issue and hopefully through Tom's new series we will have plenty to discuss.

Why did the Weisel IPO Soar?!?

The IPO of Thomas Weisel Partners took off yesterday, jumping over 30% in intraday trading. The Deal has reported that this was great news for bankers, but that it surprised most analysts. Apparently, a lukewarm welcome was expected for the IPO due to a large decline in revenue from 2000 to 2004 as most tech deals went into hibernation.

Why did the IPO soar? The Deal reports that the stock rise is likely due to fund clients at the firm who rallied together to support the IPO, despite the withdrawal of Goldman as an underwriter. Apparently, market sources say these were mostly institution tech-focused funds.

It's been a while since the "IPO Spinning" days of 1999 where major investment banks gave IPO shares to select clients of the firm in exchange for future business. This case with the Weisel IPO sounds like the exact opposite - that in exchange for buying shares in the IPO, the firm could potentially offer better pricing and service for those institutional clients. Now usually, there shouldn't be anything wrong with something like this happening. However, there are strict guidelines put out by the SEC about marketing your IPO on the IPO roadshow. A quiet period exists and investors in the offering are supposed to be convinced of participation by the prospectus and the roadshow, not by anything else. Something seems wrong with this picture...

Ironically, it is once again an investment bank at the center of it.

SIPphone vs Skype

I have been a Skype user for a while now, long before its purchase by ebay. It has worked well, particularly among more business oriented folks such as portfolio company executives and investors. I think it has caught on with the younger generations as well. Some of the problems I had with Skype were that there was no free voicemail, that you were not given a number that land users could call you at (you can pay for this), and that you have to pay to call non-Skype users.

Along came SIPphone! I have started using Gizmo by SIPphone. To all my blog readers, I encourage you to go to SIPphone and download the Gizmo. It's exactly like Skype but better. Same interface, same everthing. Here are some differences:

1. Free voicemail - They send you an email with a .wav file of the voicemail.
2. Free number - You actually get a number that anybody can call you at (although it has an obscure area code, you can pay for a premium number.
3. Cheaper - Gizmo Out calls are 1 cent per minute to anywhere in the US
4. Multiple network calling - This is the major differentiator and appears to me the most compelling reason to use Gizmo over Skype. Gizmo and Google Talk have an agreement for free VOIP within the network. Gizmo also can talk for free to several other networks and universities such as many University of California campuses.

While I believe the VOIP wars are just beginning, the philosophy of SIPphone is the OPEN network and I believe that this is always a better strategy than the adopters of the closed network. If anybody has any criticisms or comments on Gizmo by SIPphone, please let me know.