Fidelity Ventures: Ignore the Rumors, Everything's Fine

Regular readers of the blog know that I don't traffic in rumors... but I wanted to try to fact-check the info about Fidelity Ventures that I'd been hearing through the grapevine over the past week.

Four separate venture capitalists at local firms have told me that Fidelity is stepping back from its commitment to Fidelity Ventures, and looking for other limited partners who might want to put money into the next Fidelity Ventures fund. (Historically, Fidelity has been the lone LP backing Fidelity Ventures.)

"They debated shutting it down, but their intention is to raise another fund," the founder of one local VC firm told me. "My belief is that they're trying to go through a transition here from a Fidelity-controlled fund to one where it gets smaller, and Fidelity's commitments will be smaller." In 2007, Fidelity Ventures expanded the size of Fund IV from $250 million to $400 million; that's the fund they're currently investing out of.

Another managing partner at a different VC firm said he'd seen a number of resumes from Fidelity Ventures partners and associates. "The returns haven't really been there, and for Fidelity, VC and private equity may have just gotten too big and too expensive," he said.

"They've started a process to explore how they might raise traditional capital," said another managing partner. "These one-LP models don't tend to perform very well." (None of these VCs wanted to be named, since many of them have worked or may work with Fidelity Ventures at some point.)

The rumor mill also has it that Rob Ketterson, the managing partner at Fidelity Ventures, has been stepping back from an active investing role (he currently serves on just one board), and partner Larry Cheng has been taking more of a leadership role. (An aside: Ketterson is married to Elizabeth Johnson, one of Fidelity chairman Ned Johnson's daughters.)

Fidelity Ventures' two most recent investments, in Stylesight and Vibes Media, were made last September. On TheFunded.com, a "No New Investments Warning" has been posted, alerting entrepreneurs that TheFunded has received "information that [Fidelity Ventures] may not be making investments into new portfolio companies." The firm's most recent exit seems to be the sale, last April, of broadband cable solutions provider Jacobs Rimell to Amdocs for $45 million.

When I called up Fidelity Ventures partner Larry Cheng on Tuesday, he told me that "things are fine," before suggesting that I talk to managing partner Rob Ketterson for more detail. But Fidelity didn't make Ketterson available, instead dispatching spokesperson Adam Banker.

In response to my questions, Banker said that like many other venture firms, Fidelity Ventures is "taking a cautious stance" with regard to new investments, adding, "We have capital to invest." There have been "no significant changes" in staffing, he said, and "all the partners are still here." Finally, Banker said, Fidelity has "never approached limited partners outside Fidelity" to put money into Fidelity Ventures. (Update: Banker says Fidelity made another A round investment in late Q4, without disclosing the company.)

"When things are good and your liquidity events are such that you're making money and you don't require a lot of money from corporate, everyone loves [venture capital]," says Howard Anderson, ex-VC turned MIT lecturer, talking about corporate VC initiatives. "But when you've got cash calls all over the place, and you haven't had a liquidity event since the last ice age, the treasurer asks what's going on." Anderson continued, "If Fidelity [the parent company] was doing really well, this wouldn't make too much difference. But if Fidelity is facing redemptions, looking at cost-cutting, and needing more money for advertising, this becomes a visible thing."

(I'd been developing this as a Globe column, but since Fidelity says there's nothing to the rumors, this seems unworthy of further treatment...)

How the VC Scene in Boston is Changing

Sunday's Globe column dealt with the shrinkage of Boston's VC universe. Column got snipped quite a bit, so I'm publishing the full version below, along with the video.



Venture capital sector makes adjustments

For Boston’s venture capital community, headquartered on the placid plateau of Mount Money in Waltham, 2009 will be a year of wrenching change. The stream of capital flowing to venture capital firms, who invest it in innovative-but-risky private companies, is turning to a rivulet – and that means the firms themselves will have to get smaller.

“Last year, our industry raised about $28 billion in new investment capital,” says Michael Greeley, chairman of the New England Venture Capital Association and managing director of Flybridge Capital Partners in Boston. “I think we’ll raise between $8 billion and $12 billion this year, nationally. That’s a dramatic reduction. My sense is that the average fund size will be cut in half, and they’ll have to cut the number of partners who work for them as a result.”

The shrinkage of Boston’s VC sector will be tough for the VCs, obviously, and also for entrepreneurs who ascend Mount Money with their PowerPoint presentations, looking for funding to launch a company or keep one going. But it could also have a silver lining.

Here’s what’s happening.

Two local VC firms have already put together smaller investment pools than they’d hoped for. Atlas Venture, in Waltham, had aimed to raise about $400 million but wound up with $283 million; as a result, last month Atlas jettisoned two of its partners and shifted two others to less active roles. Boston-based Bain Capital Ventures will likely wind up raising between $475 million and $550 million for its latest fund, rather than the $750 million it had set out to collect. Money in a venture capital fund is typically invested over the course of a decade.

Kodiak Venture Partners of Waltham has reduced the number of investors on its roster and is shifting its focus toward life sciences and medical technology as part of an attempt to burnish its appeal to would-be investors. Andrey Zarur, a partner there, says Kodiak isn’t out looking for new money right now, but plans to be at some point in the future.

“Kodiak just hasn’t had enough liquidity events to make their limited partners say, ‘I’m ready to step up again,’” says Howard Anderson, an MIT lecturer and former venture capitalist. (Limited partner is the term for the university endowments, wealthy individuals, and pension funds that funnel money into venture capital.) One example Anderson cites is Egenera, Inc., a Marlborough company selling technology for data centers that raised $176 million but never managed to go public. Anderson should know: his old firm, YankeeTek Ventures, was an early investor in Egenera.

Many other local VC firms are on the road, talking to prospective sugar daddies. Some have been at it longer than others. Among the firms trying to scare up more money in 2009 are Boston Millennia Partners, Highland Capital Partners, Polaris Venture Partners, Prism VentureWorks, Oxford BioScience Partners, Charles River Ventures, and North Bridge Venture Partners. New firms, like Genovation Capital and a medical device oriented fund called Makaira Venture Partners, are also out trying to raise their first funds.

Venture capitalists are prohibited by the Securities and Exchange Commission from discussing their fund-raising activities. But one partner at a Boston area VC firm that’s trying to put together its next fund told me last week that fundraising is happening “on a molasses pace,” adding that “universally, everyone is going to be lower than what they’d hoped to raise.”

One reason that the limited partners are avoiding commitments to new VC funds is that many of them have formulas for how they allocate their assets. If a certain percentage is devoted to bonds, a certain percentage to stocks, and a certain percentage to venture capital and private equity, for instance, things start to look out of whack when the stock portion of the portfolio plunges and the value of the VC portion stays roughly the same. (The valuations of the private companies in a venture capital firm’s portfolio isn’t updated very frequently, unlike publicly-traded stocks.)

If a limited partner needs to get their mix of asset allocation back in order, investing in new VC funds simply doesn’t happen. (Some limited partners, including the endowment managers at Harvard, Duke, and Columbia, are actually trying to sell the stakes in VC funds they already own – but there are few buyers.)

And investors who can’t get their money into the best-performing venture firms may simply be disappointed with the financial returns they get. “I’ve heard limited partners say that the VC business, in some cases, is like getting Treasury bill returns with venture capital levels of risk,” says Michael Feinstein, an ex-VC. “If you look at the median venture capital return over the past eight years, it’s about one percent a year.”

Josh Lerner, a Harvard Business School professor who studies the venture capital industry, describes what’s happening among limited partners as “a changing of the guard.” University endowments and U.S.-based pension funds are becoming smaller players in new venture capital funds, Lerner says. But what’s not clear is who will take up the slack – though sovereign wealth funds and pension funds from Australia are two potential candidates. “We can see who’s going out,” Lerner says, “but not who’s going in.”

The upshot is that VC firms will be managing smaller funds, and some firms will go out of business. Anderson, who refers to Atlas’ situation as a harbinger of things to come, predicts that some funds that aren’t in the 25 percent when it comes to delivering financial returns will simply fade into the sunset. “Everyone will swear to be in that top quartile, but this isn’t Lake Wobegon – not everyone is above average,” he says.

Fewer firms and smaller funds will obviously mean fewer jobs for venture capitalists and the staffers who support them. It’ll undoubtedly get harder for start-ups to raise money. It will take longer, and those that do manage to attract an initial jolt of capital will get less of it than before.

“There just won’t be as much money flying around,” says Todd Dagres, founder of Spark Capital in Boston. “And there’s good in that. If you can raise money for your start-up now, there’s going to be a lot more uniqueness value than there used to be.” In other words, entrepreneurs will run up against fewer well-funded competitors than they once did. That could help the entrepreneurs and their backers both.

Still, a contracting VC universe isn’t going to be as fun to inhabit as an expanding one – at least for most people, at least in the near-term.

Most recent Globe column: The A123 Systems Back-Story

My most recent Globe column delves into the back-story of A123 Systems, the Watertown battery company that is smack in the middle of the plug-in hybrid frenzy, and apparently preparing to go public (though one might ask what's taking them so long with the S-1?)

Here's the opening:

The third time that Ric Fulop asked Howard Anderson to invest in one of his start-ups, there was no good reason for Anderson to say yes. Fulop was forming a company that would reinvent the battery, but Anderson, founder of the Boston forecasting firm the Yankee Group, had already lost millions by investing in Fulop's previous ventures.
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Fulop had come to the United States from Venezuela, where he'd started two companies while still in his teens, and then dropped out of Babson College to dive head-first into the entrepreneurial mosh pit of the late 1990s.

He started a company to stream software to PCs. He started a company to make equipment that would increase the bandwidth of high-speed Internet connections. A third start-up, Broadband2Wireless, aimed to use a network of antennas on rooftops to bring a zippier Internet access alternative to big cities.

The three companies, which together sucked up more than $100 million in funding, all failed. Broadband2Wireless, which filed for Chapter 11 protection about a year after its founding, acquired the nickname "Broadband2Cashless."

I wrote about Broadband2Wireless here, in 2001. And I wrote about Anderson's exit from the VC world here, in 2005. (Can't seem to find the column that chronicled the death of B2W, but this one mentions the CEO's resignation.)

The weekly video for the column is here:

Innovation Economy Column (and Video): Davids Competing with Goliaths

Today's Innovation Economy column in the Globe looks at two mapping start-ups based in Massachusetts, EveryScape and Povo. EveryScape is working to create photo-realistic, three-dimensional maps of the world, and Povo is an interesting amalgam of Google Maps, Wikipedia, and Yelp, with a neighborly twist.

One idea I wanted to explore was how small companies like these can, if they're successful, either become acquisition targets for the big guys (in this case, Google, Microsoft, and Yahoo) or find themselves competing head-to-head.

I had a short chat with MIT instructor/VC/analyst Howard Anderson on that topic that was quite enlightening -- but which didn't make it into the finished column. Some notes from conversation that are below the video clip, which takes you along for a ride in EveryScape's mapping-mobile.



(For a more basic explanation of what EveryScape aims to do, check out this New England Cable News clip.)

Anderson had some great perspective on the relationship between start-ups and big companies:

- Start-ups often awaken giants to the potential of a market. If the start-up doesn't move fast, "you get rolled over," Anderson says. "There is a pregnant period of time when you have to become the de facto standard. If not, and only the lunatic fringe likes your product," then you don't matter as a competitor (or potential acquisition) to the big players.

- "It's easy to compete against the big guy. They're always a little muscle-bound. They take a long time to recognize a new market. What you really have to worry about are the other small companies in the same space. I used to love backing companies that competed against AT&T and IBM. But when you had eight [start-up] companies, so much alike that their mothers couldn't tell them apart, then you never got traction."

- In meetings with big companies about potential partnerships, start-ups can often be induced by the power differential ("They're Google, who the hell are we?") to say a little too much about what they're doing. "You should talk about your vision, but if you're foolish enough to tell them everything, and show the innards of your product, then you can save them a great amount of time," Anderson says.