peHUB Wire: Monday, September 28, 2009

Twitter confirmed the obvious on Friday, with a short blog post about how it had raised a new round of VC funding. No dollar or valuation info, of course (Twitter is to financial info what Bill Belichick is to injuries), but a list of investors. They were: Insight Venture Partners, T. Rowe Price, Morgan Stanley, Benchmark Capital, Institutional Venture Partners and Spark Capital.

Notably missing from the list was Union Square Ventures, which had been an investor with the micro-messenger since the beginning. Fred Wilson, a co-founding partner of USV, even sits on the Twitter board of directors.

So what happened? Wilson declined to discuss it (basically because of Twitter’s neurosis – my words, not his), but my assumption is that it came down to an issue of size. Specifically, the round was just too large for USV. The deal reportedly was worth $100 million at a $1 billion valuation, while USV is currently investing! out of a $155 million fund. Moreover, USV originally invested in Twitter out of a $125 million predecessor fund (not sure if subsequent deals went cross-fund).

USV’s basic calculation would be that it’s better to accept the dilution in exchange for being able to add a few new portfolio companies. You need at least a couple mega-exits to generate top-tier VC returns for a $155 million fund, so the more bites at the apple the better.

All of this brings us back to the VC fund size issue, which we last discussed vis-à-vis Bill Gurley’s column about VC industry shrinkage. Before that, we discussed it when I ran data to see if VC funds that cut already-committed money in 2001-2003 outperformed the market (the results were mixed – although perhaps I should have benchmarked them against large funds that didn’t cut).

So my basic question: Is USV’s size strategy superior to a Benchmark Capital or Spark Capital size strategy?

There are no definitive answe! rs, of course, but we can take preliminary instruction from some unpub lished research by Josh Lerner (HBS) and Antoinette Schoar (MIT Sloan). They looked at how changes to fund size and firm size affect returns, and found that there is an apparent relationship.

Lerner and Schoar first took the universe of all mature VC and buyout funds (those raised through 1999), and discovered an inverted U-shaped relationship. Basically, mid-sized funds outperformed both small and large-sized funds. Peak performance was at around $300 million (note: the researched time period is admittedly dated).

They then broke out the types of funds, and found that the inverted U-shape is sharper and most statistically significant for VC funds than for buyout funds. In this breakdown, the peak VC size was $280 million compared to $1.2 billion for buyout funds.

So is the answer to have a mid-sized fund? Well, not exactly, Lerner and Schoar didn’t actually find too much performance variance based purely on size. Sure there was peak performance, but i! t didn’t vary too much from the high and low-end quartile benchmarks. For example, a $5 billion buyout fund had a predicted return of just 1.2% lower than a $2 billion buyout fund.

What is important, however, is the rate at which a firm’s fund sizes grow. Lerner writes: “We find that growth has a substantial negative effect on growth: A doubling of fund size, all else being equal, leads to a fall in IRR of -5.3%. This analysis suggests that a group that had a 25% IRR in its $1 billion dollar third fund could expect a return of only a little below 20% if it went and raised a $2 billion fund next.”

The related chart is fairly remarkable, in that the negative correlation between fund size growth and performance resembles a very steep hill.

So what is ultimately important for firms like USV and Benchmark isn’t purely the number of dollars in their current funds, but rather how that compares to the dollars in its past and future funds.

*** Cle! antech Event: We’re just about one month away from our Boston cleantech event, which will consist of an evening panel and networking. It’s all being sponsored by Bingham McCutchen. Get details and register here.

*** Correction: In Friday’s notes on the Serta/Simmons deal, I noted that it could prompt KKR to take Sealy public. Consider it a Friday brain cramp, as Sealy is already public (my proposed solution is for KKR to take it private and then IPO it again).

Top Three

American Securities has agreed to acquire GenTek Inc. (Nasdaq: GETI), a Parsippany, N.J.-based maker of inorganic chemical products and valve actuation systems and components for automotive and heavy-duty engines. The deal is valued at approximately $673 million (including $262m of assumed debt and liabilities), with GenTek stockholders to receive $38 per share (40.7% premium to Friday’s closing price). Moelis & Co. is serving as financial advisor to GenTek.

Hicks Acquisition Co. (AMEX: TOH), a blank-check acquisition company run by Tom Hicks, has received shareholder approval to buy oil company Resolute Natural Resources for approximately $582 million. The merged company would be renamed Resolute Energy Corp., and would trade on the NYSE under ticker symbol REN.

NewEgg Inc., a City of Industry, Calif.-based ecommerce company focused on IT products for small and mid-sized businesses, has filed for a $175 million IPO. J.P. Morgan, BoA Merrill Lynch and Citi are serving as co-lead underwriters. Insight Venture Partners holds a 12.7% pre-IPO position, based on a $20 million investment in 2005.

VC Deals

Livebookings Ltd., a UK-based online network for restaurant reservations and marketing, has raised $16 million in new VC funding. Wellington Partners led the round, and was joined by return backers like Balderton Capital. The company previously raised over $12 million.

Buyouts Deals

Archbrook Capital Management has acquired a majority stake in Tray-Pak Corp., a Reading, Penn-based manufacturer of custom thermoformed plastic packaging products. No financial terms were disclosed.

ComVest Group has agreed to acquire Westport, Conn.-based package delivery company Velocity Express Corp., as part of a prepackaged bankruptcy process. TH Lee Putnam Ventures held around 25% of Velocity Express’ common stock, as of May 1.

DLJ South American Partners, a private equity affiliate of Credit Suisse, has agreed to acquire 25% of Santillana, the book publishing unit of Spanish media group Prisa (Madrid: PRS). The deal is valued at approximately $362 millio! n.

Evolution Capital Partners of Cleveland has invested an undisclosed amount of equity into American Eagle Mortgage, a Loraine, Ohio-based mortgage lender providing loans in Ohio, Kentucky and Florida.

Evonik, a German industrial conglomerate partially-owned by CVC Capital Partners, has agreed to sell its Alzchem specialty chemical unit to German buyout firm Bluo. Read more…

Mint Capital, a Scandinavian private eq! uity firm, has acquired Russian pub chain Tinkoff, for an undis closed amount. Dow Jones reports that the deal came after Tinkoff’s founder posted a Twitter message about wanting to sell his 70% stake.

Platinum Equity has agreed to acquire Pomeroy IT Solutions Inc. (Nasdaq: PMRY), a Hebron, Ky.-based provider of IT services. The deal is valued at approximately $65 million, or $6.50 per share of Pomeroy common stock. Houlihan Lokey is advising Pomeroy on the transaction.

TA Associates has acquired a minroity stake in Dealer Tire LLC, a Cleveland-based provider of logistics and program management services for the replacement tire market. No financial terms were disclosed. Read more…

Time Warner Inc. (NYSE: TWX) will eve! ntually sell the Time Inc. magazine unit, according to comments by Gordon Crawford, managing director of The Capital Group (Time Warner’s largest shareholder).

PE-Backed IPOs

Myer, an Australian department store chain, plans to raise upwards of A$2.34 billion via an IPO on the Australian Stock Exchange. It plans to offer up to nearly 500 million shares at between A$3.90 and A$4.90 per share. TPG and Blum Capital took the company private in 2006.

New Look, a UK fashion retailer owned by Apax Partners and Permira, is considering a flotation next spring.

PE-Backed M&A

Abbott Labs has won the auction for Solvay SA’s drug unit, with a bid of €4.5 billion in cash. The deal also includes up to €300 million in potential milestone payments and the assumption of around €400 million in liabilities, for a total value of up to €5.2 billion. Abbott Labs bested fellow bidder Nycomed, a Swiss drugmaker owned by Blackstone Group, CS Private Equity and Nordic Capital.

Firms & Funds

China Investment Corp., a $200 billion sovereign wealth fund, has agreed to invest around $1 billion with Los Angeles-based Oaktree Capital Management, according to the WSJ.

Sun Mountain Capital has been retained by a group of public and private organizations in Arizona, to launch and operate a new fund-of-funds that would back firms that invest in early-stage companies based in Arizona. The vehicle would aim to raise upwards of $200 million.

Human Resources

Christopher Heckscher has joined Standard Life Investments as senior vice president of U.S. credit. He previously spent 14 years with Wellington Management.

Bob Grady, a partner with The Carlyle Group, has joined the board of Thomas Weisel Partners Group Inc. (Nasdaq: TWPG).

Brett Pantazi has joined mid-market I-bank Nolan & Associates as a managing director. He will work out of the firm’s St. Louis office, and previously was with National City Capital Markets and A.G. Edwards Capital Markets.

Pappas Ventures has promoted Eric Linsley to managing partner. He joined the health-care focused firm in 2000.

Stephan Wilcke, a former partner with Apax Partners, has been appointed to oversee Britain’s Asset Protection Agency, the body designed to oversee a proposed insurance plan for banks’ toxic assets. He is the APA’s first permanent CEO, replacing temporary appointee Jeremy Bennett.