Limited Partners Put Fund-Raisers Under Microscope

If you’re raising a fund, expect limited partners to really step up their due diligence – even if they are repeat customers.

That’s the message from two firms that closed new funds last week. Both ComVentures and OrbiMed Advisors each closed on follow-on funds totaling $300 million. It is the sixth fund for ComVentures, an early stage communications-focused VC based in Palo Alto, Calif., and the second fund for OrbiMed, a late-stage biotech-focused private equity firm based in New York City.

General partners at both say that they found enough interest from LPs to raise $400 million, but the LPs made it clear that they want to see VCs raise smaller funds that will return capital more quickly. They also like that fees are lower in the smaller funds.

About one-third of the LPs in ComVentures VI are new and about half of the LPs in OrbiMed’s Caduceus Private Investments II fund are new. Neither firm would disclose the names of its new investors.

LPs “are doing a lot of serious homework,” says Roland Van der Meer, co-founder and general partner of ComVentures. “They did a ton of reference calling. Even the existing ones went back.”

LPs are calling CEOs of portfolio companies, GPs at other venture firms, other LPs and anyone else to make sure the story that GPs are selling is grounded in reality.

“It’s about the people, the firm, the track record – it’s about who’s doing the work,” Van der Meer says. LPs want to make sure that the GPs whose names are on the private placement memorandum are going to fully participate in the fund, not just work 10% of the time.

For ComVentures, returning LPs spent 1 1/2 months checking out the firm to decide if they wanted to invest, while new LPs took about two months. (It started raising the fund back in April and wrapped it up in August before formally closing it in September.) Back in the go-go days of 2000, many LPs didn’t do serious due diligence because GPs were finding such strong demand in the market. “Three years ago it was a phone call [to raise a new fund],” Van der Meer says.

Carl Gordon, a general partner at OrbiMed, agrees that caution rules the day. “In general, what I’ve seen is that when you meet a new LP now they’re more skeptical than they were three years ago,” he says. “They’ve seen a lot of people come by who haven’t been able to deliver.”

LPs are trying to do some things differently to make sure GPs deliver this next time around. For example, they want to see GPs return capital before they take a profit for themselves to avoid clawbacks. “We’ve never had a clawback issue [but] they’re looking for that across the board,” Van der Meer says.

Limiteds are also asking for a term they used to get in the 1980s and 1990s that helps keep GP expenses down by requiring GPs to put up more of their own capital.

For ComVentures, the biggest hurdle was selling a fund targeting communications, a sector that has been in a downturn. It’s clear to the fund’s partners that now is the time to get great valuations, but that wasn’t always the case with LPs.

Some LPs were hesitant to put up more money when they haven’t seen a return on their previous investment. Harvard University, for one, chose not to invest in Fund VI, Van der Meer says.

On the issue of public LPs, neither ComVentures nor OrbiMed avoided them because of concerns about them disclosing internal rates of return. OrbiMed took money from one or more public LPs, but it declined to name them. “We felt it was high-quality money,” Gordon says. “We would rather that our information be confidential, but it wasn’t a deal breaker. It wasn’t something that we were that concerned about.”

ComVentures did not actively seek money from public LPs, but it did allow previous investor University of Michigan to invest in Fund VI, Van der Meer says. This despite the fact that the university released the IRR for ComVentures V and will presumably do so again for Fund VI.

ComVentures was concerned enough about the issue of confidentiality that it included a clause in the LP agreement for Fund VI that says the confidentiality agreement will be updated when “better-crafted” language is available. It spent about two days working with attorneys on the issue before opting to use the disclosure language from its Fund V as a placeholder.

The LPs didn’t mind, Van der Meer says.

Email Lawrence Aragon