Crescendo Ventures faces mute button

At what point does a venture firm end its quest to raise a new fund? For Worldview Technology Partners and Mobius Venture Capital, that point came after LPs kept telling them to “come back next year.” Crescendo Ventures also has heard a similar refrain a few times, but nonetheless plans to push on. Whether its perseverance will be rewarded, however, is in doubt.

Palo Alto, Calif.-based Crescendo began raising fund V in late 2001, less than a year after holding a final close on its $640 million fourth fund. Limited partners balked at another new fund so quickly, saying that Crescendo was investing too fast—20 deals in 2000, including many questionable investments in telecom. Investors also weren’t thrilled that Crescendo’s previous two funds were underwater.

In response, Crescendo initiated a complete overhaul that included partner terminations, a dozen write-offs and a partial management fee deferral. It also dropped telecom from its investment strategy, and added some additional personnel. By mid-2003, the firm had called down about 70% of its capital, but still was unable to garner much LP interest.

One LP, in particular, refused to honor capital call commitments. Starling Group International, based in the United Arab Emirates, believed that Crescendo had invested too quickly in the fund’s early days, and also alleged that a due diligence binder wasn’t put together until after the fund had closed. Crescendo vigorously disputed the allegations and complained that Starling wasn’t meeting capital calls. It brought Starling to arbitration to resolve the dispute. It would drag on until late last year, at which point Starling agreed to pay Crescendo’s legal fees, in exchange for being let off the hook for its capital commitment (which was distributed pro rata to other LPs).

No other LPs refused to meet capital calls, but some continue to cite dismal returns for their disinterest in doing further business with Crescendo. In fact, some Crescendo LPs have declined to meet with fellow Minnesota-based firm Vesbridge Partners, because Jeff Hinck, one of its principals, is a former Crescendo partner.

We dug a huge hole for ourselves, but have been working diligently ever since to climb out of it.”

David Spreng, Managing Partner, Crescendo Ventures

“They’ve burned a lot of bridges,” says one Crescendo LP who asked not to be named. “Maybe they can get some LPs in Asia, but it’s going to be tough in North America or Europe.”

David Spreng, founder and sole managing partner of Crescendo, acknowledges that the firm has made mistakes, but insists that the firm has turned things around since the 2002 reorganization. “We drew a line in the sand in 2002, and basically restarted our firm and portfolio,” he says. “We dug a huge hole for ourselves, but have been working diligently ever since to climb out of it.”

Spreng also claims that the fourth fund’s IRR for deals done since 2002 is top-quartile, when compared to funds raised in 2002.

VCJ obtained a copy of Crescendo’s most recent quarterly report to its LPs, and that report shows that Fund IV was 97.5% called down as of June 30, 2006. This means that it has a little more $15 million in pure dry powder. It also has about $37 million in cash on-hand and the ability to recycle another $58 million. Crescendo plans to use part of this combined $110 million to invest in up to five more portfolio companies before its new investment period expires later this year, Spreng says.

Of the 25 companies in Crescendo’s portfolio, the firm anticipates that 19 will need follow-on funding by mid-2007. Four are expected need more money in the third quarter of this year, nine in the fourth quarter, five in the first quarter of next year, and two in the second quarter, according to the report to LPs.

They’ve burned a lot of bridges. Maybe they can get some LPs in Asia, but it’s gpoing to be tough in North America or Europe.

Anonymous Crescendo LP

Five of Crescendo’s portfolio companies are identified as “fully funded”: AirBand Communications Holdings, BroadSoft Inc. (which is considering an IPO), eSilicon Corp., Fultec Semiconductor Inc. and Pure Digital Technologies.

Of the 25 active portfolio companies, only six are being held above-value (Crescendo usually marks to recent financings or realizations). Eight of the companies are held below value and 11 are being held at cost.

Crescendo also has disposed of 22 companies (see table), not including a handful of “pre-seed” deals that got written off at about 33 cents on the dollar. Of the disposed companies, 12 were written-off completely, while most of the others represented steep losses. In fact, Crescendo only has one positive realization: Sistina Software, which was acquired by Red Hat in a 3x return for Crescendo. Moreover, Sistina was led by former partner Hinck.

When you total up the figures on the fund IV disposition table, you find that Crescendo invested a total of $274 million, but realized gains of just $38 million, for a total loss of $236 million on those 22 deals.

Fund IV has lost more than 60% of its total value since formation. Spreng says he will ask LPs to mostly look at the post-2002 portfolio. The result is a positive carrying value of about 18%, but the majority of those companies are still being held at cost (plus six above cost and two below). Holding companies at cost is standard VC practice in the absence of a subsequent financing or liquidity event, but it doesn’t indicate anything about a company’s potential disposition. Instead, it only reflects what Crescendo was willing to pay at the time. And, considering its recent track record, that judgment is open to skepticism.

Clearly, Crescendo needs some positive realizations other than Sistina Software. And it needs them quickly. BroadSoft and SOISIC might be a start, and Spreng says that more such exits are on their way. If not, Crescendo may be forced to follow Worldview and Mobius out the door.