The following is the text of a letter that Sevin Rosen Funds sent to its limited partners on Oct. 6, 2006. SRF provided a copy of the letter to PE Week.
Dear Prospective Limited Partners of Sevin Rosen Fund X:
We want to thank you for your diligence and efforts as we have been in the process of finalizing Sevin Rosen Fund X. We want to tell you of a radical change in our thinking about Fund X that is the product of a series of off-site meetings that we have engaged in over the last month.
For the last two years we have been very public in describing some fundamental structural challenges that our industry faces. For those of you who were at our Annual Meeting you will undoubtedly recall some of the data we presented on the venture industry:
• Too much money.
• Too many deals funded in almost every conceivable space.
• A terribly weak exit environment:
o An IPO market which demands a level of revenue that few companies can achieve, or which takes much longer to achieve.
o An IPO market that is marked by an infrequent, rare mega-hit but a market that does not offer consistent liquidity and valuation generation that used
to be the norm over periods of time.
o Acquisition values that are insufficient, on average, to generate multiples necessary for “venture” returns.
• No changes in the foreseeable future that suggest these exit environment issues are just temporary.
• A collapse of cash-on-cash multiples that can be achieved with any consistency, as the total equity required for private companies has increased steadily driven both by competition and the longer time frame until an exit.
• The degradation in the exit environment, combined with the explosion in money and deals funded, that has led to an industry wide venture returns outcome in which the last vintage year for the entire venture industry with a materially positive cash-on-cash multiple was 1997. (It is important to note that we do not view IRR or interim result measures as all that meaningful. In the venture business, a portfolio is illiquid and therefore the only thing that matters, in the end, are actual distributions).
As we were about to close our next fund, we asked ourselves a couple of critical questions: While there are a lot of exciting new areas in which to invest, are those going to change these fundamental structural issues? If we really believe that there are fundamental structural problems in the venture industry, should we raise our fund and just hope that the problems will get better? Should we really ask our limited partners to put more money in without taking the time to try to investigate potential approaches to address these structural issues?
Despite a clear vote of confidence by a supportive group of LPs that would have allowed us to raise Fund X, we are letting you know that we have decided to take the radical step of returning the commitments you have given us for Fund X. We are stepping back to try to find different approaches that might mitigate some of the factors we have cited and that we believe can generate the returns that the traditional venture business was historically capable of delivering. We don’t have a precise timeline to tell you exactly when we will be back to you, but we are committed to figuring out the best way to thrive in this market. We will be back to you to ask you to once again support us with your commitment. In the face of our internal discussions about the state of the venture industry, we concluded that we need to put our actions where our mouths have been.
As we considered our path forward, we faced two options:
(1) Proceed to close Fund X, or
(2) Put off raising Fund X, continue to invest Fund IX and re-think how one could play the early stage venture game in a way that mitigates the structural impediments to high returns.
Our approach to choosing was simple and straightforward: If we were a limited partner, what choice would we want SRF to make? We decided the right thing was (2). We can assure that we do not take a decision to return LP commitments lightly. We believe we should give you a clear view of any change in our strategy or approach to address these industry issues before we take your commitments; and not take your money and then tell you what might change.
All financial markets and asset classes go through periods where the underlying economics change and the business models that used to work stop working as well. However, these markets quite frequently do not return to the state they were in before. While good returns from any given firm’s portfolio is certainly a possibility, the statistics have clearly shifted in an unfavorable direction. The venture environment has changed so that overall returns for the entire industry are way too low and even the upper quartile returns have dropped to insufficient levels. Our plan is to take the time to see if there is a new model that can better address the troubled exit environment than the traditional venture model has over the last decade. We look forward to coming back to and asking again for you to renew the commitments that we have reluctantly chosen to return to you.
Again, thank you for your support. We will be happy to chat with you over the coming weeks if there is anything about our decision that was not clear.
Sevin Rosen Funds