Fund-Raising Slows in Q2, Menlo Ventures Beefs Up Total

Thank goodness for the fund-raising activity of Menlo Ventures.

Without the Menlo Park, Calif.-based venture firm, pessimistic fund watchers would be shouting that the sky is falling.

That’s because fewer firms raised money in the second quarter of 2005, and they only barely raised more than their colleagues did in Q1, according to new data released today by Thomson Venture Economics (publisher of PE Week) and the National Venture Capital Association (NVCA).

A total of 43 venture firms raised about $6 billion in Q2, compared to 61 firms bringing in $5.7 billion the previous quarter, according to preliminary data from Thomson and the NVCA.

But the numbers are skewed somewhat by Menlo Ventures, which closed Menlo Ventures X with $1.2 billion during Q2. Without Menlo Ventures’ fund in the mix, VC funding for Q2 drops almost 20 percent.

Investors, however, are not concerned with the state of the market as it pertains to quarterly fluctuations. Walter Kortschak, a managing partner with Summit Partners, says it is difficult to decipher significant changes in the fund-raising market based on reports every three months. He says that changes between quarters in fund-raising is often a function of scheduling, and that a fund having multiple closings over several quarters affects the data.

“I would expect that the fund-raising environment will continue to be strong in 2005 and any difference between Q1 and Q2 was just a matter of timing,” he says. His firm closed Summit Partners Venture Capital Fund II during the recent quarter with $300 million.

Peter Martenson, a division director with Macquarie Funds Management and a former director with the Pacific Corporate Group, agrees that too much can be read by looking at the quarterly fluctuations. “Ten to 15 years ago there was more of a cowboy mentality and investing in venture capital was not as disciplined as it is today,” he says. “Sophisticated institutional investors are just realizing that they need to approach venture assets in the same disciplined way that they approach public equity and public debt portfolio construction.”

Menlo Ventures followed the route taken by many venture firms – going back to the well for fewer dollars than its previous funds. Menlo Ventures IX closed in 2001 with more than $1.5 billion. The next largest VC fund to close during Q2 was Insight Venture Partners. The New York-based firm closed its fifth fund with $675 million, which was about 10% less than its fourth fund in 2000, which closed with $740 million.

Also, J.H. Whitney & Co. closed J.H. Whitney VI in Q2 with about $550 million, following up its fifth fund which closed in 2001 with $1.1 billion.

While it’s no secret that various venture firms are largely setting out to raise less than they did in previous funds, what concerns many is that LPs could be moving away from the venture class as they eye more private equity and other alternative asset classes.

“There’s no question there’s a fair bit of capital out there allocated to private equity,” says Nadir Naini, a general partner with Frazier Healthcare Ventures. “We’re seeing a little bit of a turning away from venture capital towards buyout-oriented or real estate and other special situation funds.”

Naini says that Frazier Healthcare, which held a final close on its $475 million Frazier Healthcare V in Q2, saw more money from endowments and foundations than it has historically, though it added CalSTRS to its LP roster.

“The state pension funds are requiring such a large investment that it’s becoming more difficult for them to independently make individual commitments to venture funds,” he says. But, he notes, the buyout markets allow the larger pension groups to put more money to work at once.

Indeed, last year was a bonanza for buyout firms, as 125 funds raised nearly $52 billion, compared to 90 funds raising about $31 billion in 2004.

The Q2 data also showed that about 21% of venture funds raised in the second quarter were new funds with follow-on funds comprising 80% of activity in the quarter.

Throughout 2005, new funds make up an about 18% of all venture funds raised.