CalPERS seeks co-investment partners for first time

Venture capitalists, long accustomed to selling limited partner stakes to California’s largest retirement fund, can now get access to the pension giant’s deep pockets as a co-investor in VC deals.

Starting this year, the California Public Employees’ Retirement System (CalPERS) plans to invest directly alongside VCs through a dedicated fund focused on parts of the state considered underserved by other investment capital sources.

Through its Golden State Investment Fund, unveiled last fall and scheduled to make its first investments this year, CalPERS has put up $500 million toward its goal of investing in businesses that create jobs and economic growth in targeted areas. The fund is a successor to the $475 million California Initiative fund that CalPERS set up in 2001 to make investments in “underserved markets.”

The new Golden State fund has a twist: Only half of the money allocated will go to LP stakes in private equity funds. The other half will be invested directly in California companies by the fund’s manager, Hamilton Lane.

If it sounds like CalPERS is rushing into the venture capital business, however, think again. “We’re not a general partner and we’re not looking to compete with general partners,” reassures Paul Yett, a managing director at Hamilton Lane. Instead, the plan is for CalPERS to co-invest in individual deals following terms set by other private equity investors.

So what’s in it for venture capitalists? And how might California VCs in particular find ways to work profitably with the Golden State Investment Fund? Yett answered those questions and more in an interview with VCJ.

Q: Venture Capitalists are more familiar with working with CalPERs as an LP. How does co-investing work?

A: Co-investing is a prevalent form of investing in private equity right now. In venture, it works like this: Say a venture fund does a deal for a $10 million round, and they only put in $8 million. They can go out to co-investors for the additional funding.

In that sort of deal, the venture firm would be the general partner. They’re going to do the diligence, negotiate the terms and set the price. What we’re looking to do is to help support the funding round of that company.

Q: What’s the advantage for you in co-investments?

A: The potential advantage for CalPERS and Hamilton Lane is that we can pinpoint the exact company we’re investing in. In addition to looking for good returns, we will be looking at other factors, like job-creation potential and the ability to deploy capital in underserved markets. Also, typically we don’t pay fees or carried interest on co-investments.

The advantage for a general partner in [co-investing with CalPERS] is if they don’t have enough capital, they can get capital from someone who’s not really a competitor.”

Paul Yett, Managing Director, Hamilton Lane

Q: What’s in it for venture firms?

A: The advantage for a general partner in doing this is if they don’t have enough capital, they can get capital from someone who’s not really a competitor.

It’s also a way that we can get to know a general partner, if it’s someone with whom we haven’t invested before. We get to look at the inner workings of a general partner and to see how savvy they are relative to others in the market.

Q: Is there precedent for this sort of program among pension funds?

A: The New York State Common Retirement Fund has a program that’s similar. [That program is called the In-State Private Equity Investment Program]. They invest in venture capital in underserved markets and do co-investment. But this is the first dedicated California co-investment project, as far as I’m aware.

Q: You say the fund launched in January. Have you made any investments yet?

A: We’re close. On the limited partner side, we are in various stages of closing on about four partnerships. Two are in venture capital and two are in growth equity. We’re also reviewing a manager focused on early stage venture.

We’re also in the process of closing on two co-investments and are finishing due diligence on a third. Of those, the first two are well diversified throughout the state. The other is in the Inland Empire, east of Los Angeles.

Q: How much of the fund will go to venture limited partnerships?

A: I’m not sure, but my intention is to build a diversified portfolio and to spend the next six to12 months seeing what’s out there. While we’re certainly open to venture capital, we’re also looking at growth, expansion and buyout. In the end, I’d expect us to have about 15 managers across those asset classes and invest $5 million to $20 million in each.

Q: CalPERS’ California Initiative Fund invested in funds run by four venture firms—DFJ Frontier, American River Ventures, Garage Technology Ventures and Pacific Community Ventures. Any chance you’ll be investing in new funds from those firms?

While we’re certainly open to venture capital, we’re also looking at growth, expansion and buyout. In the end, I’d expect us to have about 15 managers across those asset classes and invest $5 million to $20 million in each.”

Paul Yett, Managing Director, Hamilton Lane

A: We may.

Q: What about venture co-investments? What qualities will you be looking for in companies you fund?

A: I think co-investments are going to be tilted toward later stage venture and growth equity. That’s largely because it’s easier for us to analyze those companies. We’re not precluding early stage venture, but my guess is it’s going to be a relatively small percentage for the co-investment program.

In terms of industries, I like the manufacturing businesses and some retail is pretty attractive. I’ve also seen a couple of interesting transportation-related businesses and a few technology companies.

Another factor is that we’re capped at no more than $25 million in any individual deal, but there’s no floor. For the right story in the right region, we might look at some deals where we’re only putting $2 million to work.

Q: Over what time horizon will you be looking for returns?

A: It’s a typical 10-year vehicle, but our hope and expectation is that we can generate some nice liquidity returns three or four years into it.

Q:

Any advice to VCs for working with the Golden State Fund?

A: My advice is to the extent you invest in California, look back in your portfolio track record at where those companies are and how they’ve performed with regard to job growth. I’ve had some venture capitalists come in and say: ‘I never though of it that way.’ But if they look back, they end up having a lot of good stories.

I’m definitely in the market for talented investors who are looking at some of these underserved markets. It’s not so formulaic as to say that if you’re a great Silicon Valley venture capitalist, you should move to Davis [a city in Northern California]. But you may have effective deal sourcing in the Central Valley area.