Venture capital disclosure has two camps squaring off

`Transparency' sought in reporting returns

Dollars & Sense

October 27, 2002|By Beth Healy | Beth Healy,BOSTON GLOBE

As the debate intensifies over public disclosure of venture capital returns, two opposing camps are forming.

There are venture capitalists who want to slam the door on the matter entirely. And there are others who are willing to discuss the notion of better "transparency" in the venture business - including the possibility of creating a system under which venture returns could be fairly and accurately reported and compared.

There's a long way to go before any truce is reached. Tom Crotty, a general partner at Battery Ventures in Wellesley, Mass., is among the avant-garde on the issue. He said he has no objection to aiming for better disclosure in the venture business.

But he is adamant that venture firms should never be forced to reveal information about the private companies in their portfolios. "That would be suicide," he said.

If firms are to make their returns easier for investors to understand and compare, Crotty said, the industry will have to adopt a standardized approach to valuing portfolios and calculating returns.

"Right now, trying to compare returns between venture firms is like trying to compare a pineapple to a grape," Crotty said. "Unless there's some better standardization process, it's dangerous to get this information out there."

It's dangerous, venture capitalists and their lawyers argue, because the numbers could easily be misinterpreted by people outside the business. Consultants, politicians and reporters could spread word of unfavorable numbers posted by a venture fund without the proper context to explain those figures, they said. And rivals within the business could use ugly numbers to embarrass a competitor.

The hypersensitivity rears its head mainly in the first year or two of a venture fund. In the best of times, these funds, which generally are 10-year investments, look like losers for a year or two. That's because investments are just beginning to be made, fees are being drawn by the venture firms, and there are no payoffs yet in the form of acquisitions or initial public offerings of portfolio companies. And in these gloomy times, young funds are looking more dreadful than usual.

A fund launched in 2000, for example, is likely to have made several investments at top dollar. As the market slumped, so did the private valuations of those companies (a complex calculation in itself) and there have been few so-called liquidity events to make money on those deals. As a result, most funds launched over the past two years look dismal on paper right now; some are down as much as 33 percent.

Talk about uncomfortable timing. The venture capital industry is being pressured to open its doors just as it's grappling with the worst financial landscape in its history.

A showdown last month at the University of Texas blew the lid off the privacy discussion across the industry. The Texas attorney general ruled, in response to records requests by the Houston Chronicle and others, that the university's endowment had to make public its venture capital returns. It was the first time a public pension fund had been forced to break the confidentiality agreements that are standard with most venture contracts. The performance numbers were to be expected: strong results for older funds and mostly red ink for new funds.

Another newspaper, the San Jose Mercury News, recently sued the nation's largest pension fund, the California Public Employees' Retirement System, or Calpers, for venture return data, saying, "California residents have the right to know how the pension fund's private investments are performing."

Brad Pacheco, a Calpers spokesman, said, "We're trying very hard to balance our fiduciary duty to our investors with our desire to participate in this asset class."

Executives of some venture firms have warned in speeches that they would shut out public pension plans if those groups were unable to uphold their contractual promise of confidentiality.

"We hope to get a useful resolution in court," Pacheco said.

Threats to shut out the pension community from future funds may seem unimportant at a time when venture returns are poor. But participating in top venture funds has been hugely profitable for institutional investors over the long term.

Venture returns have averaged 20 percent a year over the past two decades, according to Venture Economics, a New York research group.

One reason it may be easy to shut out pension plans in the future is that venture capital funds are shrinking back after several years of growing into $1 billion monstrosities. If the next round of funds is begun at half that size, or smaller, investors will be elbowing each other to get in, and public pension funds have never been any venture capitalist's favorite investor. Such funds are rife with politics and management changes that wealthy individuals and endowments don't bring to the table.

Venture Economics points out that venture capitalists raised about 20 percent of the money for their funds from public pension plans last year.

Private Equity Analyst, a Wellesley, Mass., trade journal, found that public funds provided 41 percent of new buyout funds' cash last year. An additional 10 percent of the buyout firms' money came from corporate pension plans.

Considering those numbers, says Dave Barry, a senior editor at Private Equity Analyst, "I just don't see public pension funds suddenly being out of the equation."

The threat remains, but some key figures in the venture community are trying to find ways to address an issue on which everyone seems to agree: Venture returns need to be clearer, even if it's just for the benefit of the current investors.

Josh Lerner, who teaches venture capital courses at Harvard Business School, said demands for greater disclosure and transparency in the venture business are inevitable, given the industry's astronomical growth over the past 10 years.

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