NEA, One of the First Mega-Funds. Will Smaller Funds Survive? NEA, for as long as most of us can remember, has been an elite leader in the venture capital industry. It comes as no surprise that NEA was listed at the top of all venture funds in terms of number of investments for the three months and nine months ending 9/30. We have seen NEA at the top of about every list for two decades, including key ones such as number of IPOs from its investments. In October, NEA announced it had reached its target of $2.5 billion for NEA Fund XIII. To put this in perspective, only eight other U.S. firms have raised billion dollar plus venture funds since 2004, and NEA is only one of two to raise this level of capital since the beginning of 2008. NEA has been raising billion dollar funds since 2000. Fund VIII in 1998 was the first to cross over the $500 million level. In venture capital, the only measure of success for the investors and the partners is a fund’s return. Growth for growth’s sake may work in the public markets, but it holds no water with the limited partners who provide the money for funds. Eventually, you must return capital to investors or close up shop. So it begs the question, why has NEA grown so large? How does this help produce better returns than the industry? Is this a calculated strategy or the consequence of some inexorable market momentum? Knowing some of the principals and founders as we do, we are dead certain that it is the former. No one in their right mind would take the time or trouble to organize and grow prima donna venture partners, unless the evidence for a growth strategy compelled you to do so. We have seen many self-serving arguments for why small and medium sized funds will produce better returns in this market, but there is no convincing evidence for this hoped for trend. Meanwhile, smaller funds are being strangled as they struggle to raise money from limited partners who “flee to safety’ in the larger funds. What if the reality of venture investing is that it will mature along a model found in other financial segments and other industries? What if the answer is simply that bigger is better? In specific, what if larger investments in larger venture worthy companies are less risky than smaller investments in smaller companies? What if a large portfolio of large investments (and by that we mean investments that need at least $20M to merit attention) has less variability and risk than a diversified portfolio of smaller sized investments? Did we not learn in the high yield arena how difficult it is to maintain a viable market focused on middle market companies? Today, high yield, with all of its risk and defaults, is exclusively focused on large cap opportunities. For industries in general, is it not true that as they mature, the strong get stronger and larger, ultimately forcing the small and middle market players off the playing field? The modern era of venture investing is less than twenty years old. In a year when NEA can hit its $2.5B target, scores of mid-sized and small funds cannot lure a dollar to their cause. Scores of these funds are closing their doors or going on life support. If you look at NEA’s track record (see Sept. Mid-Atlantic Deal Review, News Notes, “CalPERS”), it becomes clear why a CalPERS has a fiduciary responsibility to choose NEA over dozens of other funds that it has invested in. How much of NEA’s returns are idiosyncratic, based upon good management, training and internal controls? How much is dependent upon the ability to invest large sums in large projects through a score of general partners that the majority of the venture industry is constrained from considering? In U.S. investment banking and commercial banking, we are now down to a handful of mega players such as Goldman, Morgan Stanley, Bank of America, Citibank and JP Morgan Chase, with dozens of small players plying market niches underneath. We have seen a major shakeout of small and middle market venture funds in the Mid-Atlantic region. If the future belongs to the NEA’s, then entrepreneurs and early stage companies who need $2M to $15M to grow their ideas will know no relief from the onerous funding environment they face now.
