Upstarts: Rookie Venture Capital

The role reversal wasn't fun.

It took Long and his partner nearly 18 months to raise a comparatively modest fund of $20 million--"a long time," Long concedes. They had hoped to raise the money from the same big pension funds and banks that invested in Southwest. ("Since we had contacts there, we thought that we'd visit with them first.") Bad idea: the big institutional investors, it turned out, weren't about to entrust their money to a puny upstart. "Until you've experienced raising a first fund," says Long with a sigh, "it's tough to know how hard it's going to be."

Yes, it's easier than ever to raise a venture fund these days, but that's not to say it's easy. Even in an environment flush with cash, even with ever-greener venture capitalists obtaining money, a strong bias against first-timers remains.

Take the experience of Frank Greene, whose New Vista Capital began operations in early 1997. Greene has an impressive résumé: an engineer with three decades of business experience, he had started two software companies. But his credentials didn't exactly propel investors toward their checkbooks. "I found there were more ways for people to tell me 'no' than I knew were possible," says Greene. Before getting the fund off the ground, he had to take on a seasoned venture capitalist as a partner, and it still took four years to raise the fund's initial $36-million bankroll.

Joining forces with a veteran venture capitalist is not the only expedient to which tenderfoots have resorted. To raise his New World Equities fund in 1996, former Chicago investment banker Chris Girgenti felt compelled to offer investors a sweetened deal. Instead of the standard 80-20 split, by which investors receive 80% of any payout, New World offered a highly unusual 85-15 split.

To boot, he and his partner invested $5 million of their personal money in the fund to assure investors, in Girgenti's words, "that whatever we're doing with your money, we're doing with our own."

Stooping to terms that conciliatory, says a veteran venture capitalist, is "deadly" because "if you're having to compromise to get money, then you probably shouldn't get it."

Train wreck ahead?

As one who raises money from investors to create funds that invest only in venture-capital funds, Diana Frazier is closely tied to the venture-capital industry. In 1994 she cofounded FLAG Venture Management, based in Stamford, Conn., which exemplifies a new kind of financing entity known as a "fund-of-funds." Frazier, a former president of BancBoston Capital, has a front-row seat for the explosion of new venture-capital firms. She recently spoke with Inc. senior writer Jerry Useem.

Q: What's the point of an intermediary, such as FLAG Venture Management?

A: All our investors are individuals, who are also entrepreneurs and members of the Forbes 400 list of the wealthiest families. They want to start investing in venture capital. But it's nigh-on impossible to invest in top-tier funds today. People are vying to invest so much money in them that the funds get to pick and choose which investors they invite into their hallowed halls. So people who are left out invest with us, and we get them in on the ground floor of the best early-stage funds.

Q: Are a lot of inexperienced venture capitalists cropping up?

A: We've been astounded at how easy it's been for first-timers to raise money in the past year. It's a trend that we don't like.

Q: Why not?

A: Venture capitalists aren't born overnight. The mechanics of running a fund often elude them. People say, "Wow, this is a smart person, he founded a company, of course he'll be a good venture capitalist." But it takes experience, it takes mentoring, it takes seeing 20 other small companies fail. Smart is a necessary--but not a sufficient--condition.

Q: What mistakes do first-time venture capitalists make?

A: They sometimes are very reluctant to look in the mirror and be honest about what their portfolio looks like. We invest in a firm called Information Technology Ventures, and one of the key signals for us was when they wrote off their first deal. We thought that took incredible guts. Most first-time funds pretend that a loser still looks good and hide the problems under the rug.

Q: How will the newcomers fare in the long run?

A: History has it that they won't do well. What we're seeing now reminds me a lot of 1982 and 1983, the last time the number of first-time funds skyrocketed. A lot of inexperienced investors were investing in a lot of inexperienced venture-capital funds. It was just a disaster. A lot of those funds never saw the light of day again.

Q: Will the current frenzy end badly, too?

A: The gap between the premier funds and the rest will grow even bigger.

Rookies' angles: A sampler

Among venture-capital firms started since 1995 are these, each with its own investment angle:

Venture capital is just one way to raise money. Explore other options at www.inc.com/magazine/19981101/ .