Hamilton Lane: Watch Out For That Bus

If you’re trying to raise money from mega fund-of-funds Hamilton Lane, don’t be surprised if you’re asked about bus accidents.

“I kind of like to refer to it as the hit-by-the-bus clause,” says Paul Yett, vice president and general manager of venture capital at Hamilton Lane. “The question I ask is: If John Smith gets hit by a bus, what is going to happen to the fund?’ Because John Smith is critical to the historic success of this firm, so without him this is not something we would be willing to invest in.”

Founded in 1991, Hamilton Lane has initiated over $23 billion in commitments on behalf of institutional investors to more than 240 investments around the world. The firm, based in Bala Cynwyd, Pa., has $7.4 billion under management devoted to private equity investments, with 13% of that allocated to venture.

Arm Twisting

The issue of identifying a key person on which a limited partner’s investment depends is a sensitive one for private equity players, who like to think of the success of their funds as a result of a team effort. But the issue must be addressed, Yett says. In at least one case, he was able to convince the partners of an unnamed venture fund to agree to a “key-man clause.” The clause says that the fund will cease new investments and go into a harvest mode if a key general partner leaves the fund and the firm can’t develop a succession plan that’s acceptable to its limited partner board of advisors.

These days, Yett is finding VCs much more willing to accept terms they would have balked at two or three years ago. “The limited partner community seems to have more power in this market, in terms of getting the partnership agreements back in line to where they were before 1998 – with 20% carried interest and 2% to 2.5% management fees,” he says.

In December, Yett convinced a firm that is currently in the process of fund raising to reduce its carried interest split from 25% to 20%. “We structured it so their carried interest can go up, but it has got a significant hurdle to this, because the increase is tied to the gross IRR [internal rate of return] of the fund and a cash-on-cash return multiple,” he says. In order to get the bump up to 25% the firm needs to produce a return of at least 2x committed capital and a 25% IRR, he says.

“I always appreciate dealing with investors who know about the business and Hamilton Lane fits into that category,” says DuBose Montgomery, a managing director at Menlo Ventures. “We didn’t have any issues with them when we were fund raising and thought they were very good people to work with.”

Likewise, Salem Shuchman, a general partner at Apax Partners Inc., says he’s “very impressed” with the firm. “They are known for their thorough due diligence and are clearly an advocate for their clients,” Schuchman says. “They also know the issues and trends impacting both limited partners and general partners and can bridge the gap.”

As tough as it is with terms, Hamilton Lane won’t go so far as to withhold capital for a floundering fund. “We won’t breach a partnership agreement, but I would have no problem, if a general partner does a horrific job … going to the general partner and doing whatever we could, and whatever was in our right to do, to suspend new investments or commitments,” he says.

The biggest challenge facing Hamilton Lane right now is finding quality investment vehicles. Most of the venture world’s top firms have already come to market and will not need to raise new funds until mid-2003, so Hamilton Lane will probably invest in fewer partnerships this year, Yett says.

In its quest for new investments, Hamilton Lane often looks for firms that can show they have some sort of unique access to deals or whose partners have distinctive skill-sets. For instance, it may look at a firm that sources most of its deals from universities.

Hamilton Lane doesn’t have hard-and-fast rules regarding the funds it backs, and it is willing to screen any opportunity in the market, Yett says. Nonetheless, the firm tends to do more deals with established firms with a demonstrated history of success. “The bar is higher for first-time funds, but we don’t turn down first-time vehicles just because they are first-time funds,” he says.

Opportunity Knocks

Despite being a fund-of-funds, Hamilton Lane doesn’t try to find particular investments for specific clients. “When I am looking to find the best opportunities out there, it doesn’t necessarily matter what client goes into that vehicle,” Yett says. “My recommendation is just that this is an attractive fund to invest in.”

When Yett identifies a fund worth backing, he brings the deal to Hamilton Lane’s eight-person investment committee for a vote. To receive backing, a fund must get unanimous approval from the committee.

Once a fund gets approved, Hamilton Lane’s portfolio managers decide where the investment should come from. They might invest out of their fund-of-funds or on behalf of a client who has given the firm discretionary power over its capital. They may also pass the potential investment on to a non-discretionary client that decides whether to invest on its own.

Even though he’s seeing fewer quality investment vehicles, Yett says he’s optimistic about the performance of funds created in 2002 and 2003. “With a slower pace, a better pricing environment and the ability to get favorable term sheets, I think these funds should do well,” he says.