Buyout bust a possible boon for venture

As buyout firms cut back the pace of mega-deals amid a challenging environment for raising debt, limited partners are looking more closely at other sectors of the private equity market. That shift in focus could provide a boost to venture firms.

Such was the viewpoint of LP market watchers attending this month’s IBF Early Stage Venture Investing Conference in San Francisco, regarding the climate for venture fund-raising. While no one predicted a radical change in the status quo, panelists indicated fund-raising may become a bit easier for VC firms.

Paul Yett, managing director at private equity asset manager Hamilton Lane, noted that over the last few years, limited partners have put large sums into the buyout space. “Now they’re saying, ‘I have way too much exposure on the mega end of buyouts,’’’ he told early stage venture fund managers at the conference. “You’re coming into a fortunate market right now.”

So far, a rise in LP interest in venture assets has yet to show up in fund-raising numbers as venture fund-raising dipped in the third quarter, according to Thomson Financial (publisher of PE Week) and the National Venture Capital Association. In all, 59 venture capital firms raised $6 billion in the summer months, a drop from Q2, during which 83 funds raised $9 billion. In the first three quarters of 2007, venture firms raised nearly $21 billion or about 79% of the volume raised in the same period of 2006.

The fund-raising climate for mangers of emerging funds is “as tough as it’s ever been,” said Robert Hofeditz, a partner at private equity placement firm Probitas Partners.

A few years ago, the average length of time to raise a new venture fund without existing LPs was nine to 18 months. Over the past year, Hofeditz said that it has stretched to between 18 and 24 months.

Established funds are raising the lion’s share of money, with the ratio of follow-on to new offerings exceeding 6 to 1. Only eight new venture funds were raised in the most recent quarter, compared to 51 follow-on entities. This represents the smallest number of new funds raised since the second quarter of 2003. However, the total funds raised by new funds was $554 million, exceeding the dollar volume in five of the last 12 quarters.

Fund-raising may pick up. Investors who have plenty of cash to invest are expanding their emerging manager programs, said Thomas Beaudoin, a partner at Wilmer Hale, who specializes in fund formation. “They’re basically saying: ‘I can’t get into Sequoia Capital. Where else can I look?’” he said.

Beaudoin said that if influxes to buyout firms drop, then billions of dollars will be freed up to invest in other asset classes. He said that some of that could trickle down to venture.

LPs remain concerned about venture valuations, fund fees and prospective ROI, said Julia Feldman, vice president of the private equity group at Goldman Sachs. Feldman said she has reviewed more than 100 venture funds in the past year and is concerned that “things are getting a little frothy.”

LP investors recognize that there’s a limited supply of suitable companies for venture funding, said Georganne Perkins, managing director at private equity fund of funds Fisher Lynch Capital. Early stage venture capital, in particular, is not a scalable model, she said as she noted that “the industry can only accept so much money per year.”