TRS of Texas considers direct investments

The Teacher Retirement System of Texas last week was scheduled to discuss a gubernatorial request that it allocate up to $600 million for direct venture capital investments into Texas-based companies and related technology endeavors. If approved, it would rank as the largest venture capital fund based in Texas.

TRS currently makes all of its venture investments as a limited partner in unaffiliated venture capital funds, as do most public pension systems nationwide. For example, its upcoming alternative assets committee meeting will consider fund commitments to new offerings from both Leonard Green & Associates and Providence Equity Partners. Also similar to most public pensions, TRS buttresses a fairly meager alternatives staff with third-party consultants (Hamilton Lane, in this case). As of August 2005, about 3.3% of the $93.32 billion system was invested in alternatives.

But a new proposal from Gov. Rick Perry is an attempt to shake up the TRS model to promote local economic growth. Specifically, Perry is concerned that the local venture capital community has all but dissipated in the post-bubble years, and that the result is an unfair disadvantage for Texas-based startups.

Texas receives the third-most venture capital of any state, but is far closer to numbers 4 through 10 than it is to numbers 1 (California) and 2 (Massachusetts). Moreover, VC-backed Texas companies received less than 25% of their funding from local investors so far this year, compared to more than 36% for Massachusetts-based companies.

“I think what we’ve seen is an over-correction since the bubble,” says Stephen Straus, a former Austin Ventures pro who currently is forming a new early stage fund in Texas. “We’ve had almost no new funds begun since the bubble because lots of angels or would-be fund managers only got into the market in 1998 or 1999, so their only experience with the asset class is of being burned. … People aren’t necessarily aware of the problem because so many bubble-era companies are kind of masking the lack of new VC-backed companies.”

The first governmental attempt to tackle the problem came two years ago, when Perry and state legislators formed the Texas Emerging Technology Fund, a $200 million vehicle that makes direct early sage plays in Texas-based technology companies; matching funds for federal grants; and attempts to attract top academics and others with a strong history of commercialization.

So where does the new proposal come in? Perry wants TRS to allocate up to $600 million for follow-on investments for existing TETF portfolio companies/efforts. TRS would not be required to participate in any particular deal, while the portfolio company would likewise be permitted to secure funding elsewhere. Consider TRS to have “introductory rights” instead of “right of first refusal.” If TRS says yes, Perry also plans to ask other state systems, such as UTIMCO, to participate.

A legal staff memo for TRS suggests that it would have two ways to enact such a program: Either it could hire some in-house staffers to evaluate and manage the portfolio, or it could retain a third-party manager. The attorneys recommended the latter option.

At least two TRS trustees are on the record as supporting the allocation, but have been countered by newspaper editorial board criticism that TRS should focus all of its investment efforts on getting the best returns, wherever they are found. Moreover, there is some implied concern that this new program could be used as follow-on cover to boost TETF’s interim performance data.

Straus is not a fan of the specific proposal, because he does not believe TRS should be involved in direct investing. However, he does feel that the state should form a fund-of-funds dedicated to in-state managers. This might look like corporate welfare in the short-term, he admits, but it could help rebuild what would become a self-sustaining VC ecosystem.