PE Week Wire, Oct. 9, 2006

Sevin Rosen Funds has indefinitely postponed fundraising for its tenth fund, which had been scheduled to hold a first close this week. This is being treated as big news in VC circles – particularly among the battering blogbobs – because SRF is not citing the typical excuses of partnership strife or fundraising difficulties (i.e., Mobius, Worldview, etc.). Instead, it claims that the VC model is “severely damaged,” and that it will not raise additional capital until it finds a responsible solution.

Please forgive my impertinence, but SRF is wrong in its premise. The VC model isn’t severely damaged. It’s the VC firms themselves.

I spent 40 minutes on the phone last night with Steve Dow, a general partner with SRF for more than two decades. He elaborated on a letter sent last Friday to prospective limited partners, in which SRF argued that the exit environment for VC-backed companies has fundamentally changed for the worse. Part of the blame will sound familiar to those who read last week’s discussion with MPM Capital’s Paul Brooke, in that VC-backed IPOs have been hindered by (A) SOX-required separations between I-bankers and analysts and (B) Impatient hedge funds becoming larger IPO buyers than more patient mutual funds.

Dow also does not believe that the M&A market can adequately make up for IPO market failures, because VCs have created a buyer’s market by over-funding just about every sector. Sure there are a few homeruns, but a surprisingly high number of M&A deals actually are $1 dispositions that don’t get included in the quarterly “disclosed value” data. And, without a viable exit market, VCs are setting themselves up for a second-straight decade of cash-on-cash losses (which could begin in 2008). SRF doesn’t want to be a party to that.

All good points, and ones that have been raised previously by Battery Ventures founder Howard Anderson, Matrix Partners founder Paul Ferri and Greylock partner Bill Hellman. The key difference, however, is that both Matrix and Greylock keep raising new funds, while Anderson continues to invest in them as an indivudal limited partner (even though he officially said “Goodbye to Venture Capital,” after shuttering YankeeTek Ventures).

Why? Because Anderson, et all realize that a strict early-stage discipline – with just a few opportunistic expansion plays — can still produce strong results. Even Dow acknowledges that some of SRF’s best hits lately have come from companies that it seeded, not from ones it jumped into bed with at Series B or Series C. Too many firms have spent the past few years rushing downstream in the name of risk aversion, without realizing that the water is actually safer up above. These shops might get shaken out when all is said and done, but that’s more on them than on the VC model itself (which they abandoned).

The exit environment is undoubtedly tough, but early-stage investing means that you don’t need your average exits to be quite so enormous (since your starting valuations are lower). This opens up plenty of alternative exit avenues, including reverse mergers with public shells, AIM-listings and sales to small-cap or mid-cap buyout firms. Marry a few of these with one or two homeruns – which VC funds of any era have required for success – and you’ve produced strong ROI for your limited partners.

I think that Dow and SRF realize all of this, and perhaps just began fundraising before giving the matter enough thought. SRF is properly asking investors for some alone time before returning to market, and I think that SRF’s LPs will stand by their firm. But, as always, there there will be some roadblocks:

SRF wants to add some young talent, to deal with pending succession issues. The difficulty, of course, is that few promising VC prospects are going to join a firm that offers no new fund carry in its foreseeable future. Dow seems unfazed by this prospect, and in fact claims that SRF’s decision in this matter will make the venerable shop even more attractive. Unless the average VC begins valuing market philosophy over compensation, I don’t see this happening.

There also is a concern that other VC firms could begin picking off existing SRF partners. Dow also is not worried about that, saying that the current group is remaining intact (save for Steve Domenik, who previously announced his intention to leave).

Finally – and this should be the most worrisome issue for SRF – I wonder if LPs will, indeed, come back. Why? Because SRF still has enough Fund IX dry powder to add between six and eight new portfolio companies, plus lots more for follow-on investments. If the VC model is so broken, why keep investing? Isn’t SRF throwing good money after bad? Dow didn’t really have an answer for that one, and my guess is that more and more LPs will be asking it as the firm’s self-examination goes forward.

Top Three

Osprey Acquisition has increased its bid for UK water and waste management utility AWG PLC (LSE: AWG) from £2.2 billion to £2.5 billion. Osprey includes 3i Group, CPP Investment Board, Colonial First State, Industry Funds Management and a unit of Commonwealth Bank of Australia. The increased offer reportedly is in reaction to news that RWE has been receiving £10 billion bids for Thames Water, and that losers of that auction could turn their sights to AWG.

Augustus Energy Partners LLC has raised $228 million in startup private equity commitments from Greenhill Capital Partners, Kayne Anderson Capital Advisors and Lime Rock Partners. The Billings, Mont.-based upstream energy company was recently launched by former executives of U.S. Exploration Inc., which was sold earlier this year for $411 million to Noble Energy Inc. (NYSE: NBL).

Hyundai Communications & Network, a Korean cable television group controlled by Hyundai Department Store, has sold a 33.5% stake to The Carlyle Group for approximately $166 million.

VC Deals

Advanced Micro-Fabrication Equipment Inc., a Shanghai, China-based developer of plasma etching and chemical vapor deposition equipment for use insemiconductor fabs, has raised $38 million in Series B funding. Goldman Sachs led the deal, and was joined by return backers like Bay Partners, Global Catalyst Partners, Lightspeed Venture Partners and Walden International.

AirPlay Network Inc., a Carmel, Calif. designer and seller of cell phone-based interactive games, has raised $14 million in Series B funding, according to a regulatory filing. JK&B Capital and Onset Ventures were joined by return backers Redpoint Ventures and Qualcomm.

Jacket Micro Devices Inc., an Atlanta-based provider of RF modules for wireless products, has raised $12 million in third-round funding. Intersouth Partners led the deal, and was joined by return backers Noro-Mosley Partners, Sevin Rosen Funds and Imlay Inv*stments. Inc., a Santa Monica, Calif.-based company that allows users to book doctor’s appointments online, has raised $2.5 million in Series A funding led by Spark Capital. The company is led by former MapQuest chief Tommy McGloin.

3point5 Inc., a Salt Lake City-based provider of online retail sales training, has raised $1.5 million in Series B funding, according to a regulatory filing. Backers include vSpring Capital, Huffman Capital Partners and Longbow Holding Co.

Total Brand Security, a London-based provider of brand protection and counterfeiting prevention solutions, has raised £250,000 from The Capital Fund.

Buyout Deals

JHW Greentree Capital, an affiliate of J.H. Whitney & Co., has acquired a majority stake in the Advanced Metrology Systems business of Royal Philips Electronics (NYSE: PHG). No financial terms were disclosed. AMS provides metrology solutions to semiconductor manufacturers.

Veritas Capital has agreed to acquire Cornell Companies Inc. (NYSE: CRN) for $18.25 per share. The total deal is valued at approximately $518.6 million, including the assumption or repayment of approximately $273.6 million in debt. It is expected to close at the end of Q1 2007, pending shareholder and regulatory approvals. Cornell is a Houston, Texas-based provider of corrections, treatment and educational services outsourced by federal, state and local governmental agencies.

Northwest Capital Appreciation has acquired Northern Crane Services, an Edmonton, Alberta–based provider of mobile crane services to energy companies working in Western Canada. No financial terms were disclosed for the deal, which was done in partnership with company management.

Langholm Capital has acquired Elvi Ltd., a UK-based fashion retailer for plus-sized women. No financial terms were disclosed for the deal, which was done in partnership with former White Co. managing director Oliver Spark.

PE-Backed M&A

ExaProtect, a France-based provider of core security event management, has agreed to acquire Solsoft Inc., a Mountain View, Calif.-based provider of security policy management solutions. No financial terms of the deal were disclosed, except that it is supported by VC backers of both companies. ExaProtect shareholders include CIC Innovation and Elaia Partners, while Solsoft has raised around $46 million from firms like CITA Gestion, Carlyle European Venture Partners, Credit Agricole Private Equity, Innovacom, Intel Capital, Logispring, Rothschild Ventures, Sofinnova Partners and VSPA.

VNU Group BV has offered to acquire the 39.5% of NetRatings Inc. (Nasdaq: NTRT) that it does not already own, for $16 per share. VNU is controlled by a private equity consortium that includes AlpInvest Partners, Blackstone Group, Carlyle Group, Hellman & Friedman, KKR and Thomas H. Lee Partners.

PE Exits

Kenexa Corp. (Nasdaq: KNXA) has agreed to acquire BrassRing LLC, a Waltham, Mass.-based provider of talent management solutions. The deal is valued at approximately $115 million, including $10 million in net cash, and is expected to close later this quarter. BrassRing has raised around $183 million in total VC funding since its 1999 inception, including a $15 million 2001 deal with a $144 million post-money valuation, and a $40 million down-round in 2002 at a $75 million post-money valuation. Backers include Accel Partners, Gannett Co., Kaplan, Tribune Co. and the Washington Post Co.

Pfizer Inc. (NYSE: PFE) has agreed to acquire PowderMed Inc., a UK-based developer of DNA-based vaccines for conditions like influenza and chronic viral disease. No financial terms were disclosed. PowderMed backers include Abingworth Management, Advent Venture Partners, Isis College Fund, Oxford Bioscience Partners and SV Life Sciences.

Summit Partners is planning to sell its remaining 4.5 million shares of Nighthawk Radiology Holdings Inc. (Nasdaq: NHWK) via a secondary public offering.

Firms & Funds

Capital Today, a Shanghai-based growth equity firm, is targeting $280 million for its inaugural fund. It is being led by Kathy Xu, former managing director in charge of China, and recently received a $30 million LP commitment from CDC, a UK government-backed private equity organization focused on emerging markets.

Aureos China Capital is raising $70 million for its inaugural fund, which will focus on small and mid-sized businesses in the Shandong province in Eastern China. It recently received a $20 million LP commitment from CDC, a UK government-backed private equity organization focused on emerging markets.

Advanced Technology Acquisition Corp., an Israel-based blank check acquisition company focused on Israeli companies, has filed for a $200 million IPO. It plans to trade on the OTC, with CRT Capital Group serving as lead underwriter. Company management includes Moshe Bar-Niv (chairman) and Liora Lev (CEO) of Ascend Technology Ventures, while the board includes Shuki) Gleitman (Platinum Venture Capital Fund), Elisha Yanay (Motorola) and Avignor Kaplan (CLAL Insurance Pensions & Finance Group).

Istithmar PJSC has acquired a 2.7% stake in UK bank Standard Chartered, for approximately $1 billion.

Human Resources

Søren Mouritsen has joined MVM Life Science Partners as an entrepreneur-in-residence. He is a serial biotech entrepreneur, who has co-founded such companies as Pharmexa, Combio and Inoxell.

Alta Partners has promoted Alison de Bord to director. She joined the firm as an associate in 2001, and later was promoted to principal. She represents Alta on the boards of Aegerion Pharmaceuticals, Insulet and SurgRx. In other Alta Partners news, Adam Tomasi has joined the firm as a Kauffman Fellow. He previously was a student in the Harvard-MIT Biomedical Enterprise Program, and has held scientific positions in medicinal chemistry at both Cytokinetics and Gilead Sciences.

Mitchell Otolski and Erin Ellis have joined Liquid Realty Partners as assistant controller and portfolio analyst, respectively. Otolski previously was a finance analyst with Gryphon Investors, while Ellis holds a JD from American University Washington College of Law.