Lacking new money, area VC industry contracting

BYLINE: Craig M. Douglas

Massachusetts' venture capital community is contracting despite a nationwide boom in startup investing, a trend that has local industry leaders worried that the state's greatest economic assets -- its sources for ideas and capital -- are increasingly being lured to other regions of the country.

A Boston Business Journal analysis of fund-raising databases and dozens of news releases shows that of the area's 116 documented venture firms that were active or founded during the Internet bubble years of 1999 through 2001, more than half -- some 64 firms -- have shown no public evidence of raising another dollar since. And in the world of venture capital, if you have no money to invest, you may as well be picking daisies.

Interviews with the current and former principals at some of those 64 firms indicate that, for the most part, their investment days are over. Many have seen major financial backers pull the plug, while some have merged with or sold their portfolios to more experienced firms. Others cling to the fading possibility of raising more funds, even though their uninspiring track records remain a tough sell to new investors.

"It's a cohort of funds that is effectively obsolete," said Michael Greeley, a general partner with IDG Ventures Boston and the president of the New England Venture Capital Association. "At the risk of sounding a little obnoxious, there is a stereotype that these were firms created during the bubble when everyone thought investing was really easy."

The culling comes despite a renewed interest among limited partners -- the pension funds, endowments and other wealthy investors who finance venture capital funds -- to pump even more money into the sector. The surge, which helped deliver over $24 billion to U.S. venture funds last year, is pooling more and more money among the most experienced venture capitalists and brand-renowned firms.

The development hurts Massachusetts in two ways, local venture experts say. For one, it forces "successful" firms to put larger sums of money to work, boosting their average deal size in the process. At the same time, the need for bigger deals make it harder to justify smaller investments in a new generation of developing companies.

That's cause for alarm in an area such as Massachusetts, which draws huge economic gains from its status as a business and technology incubator. "We do not have enough firms doing early-stage investing here because there is so much money to be made in bigger, later-stage deals," said Dana Callow, the managing general partner at Boston Millennia Partners. "Massachusetts is going through this evolution right now."

Meanwhile, the consolidation is causing capacity constraints at local venture firms, forcing many to look beyond Massachusetts when deploying their cash. Some even have set up satellite offices and established ties to industry groups in fast-growing regions, such as the southern and southwestern United States, to assist their searches.

Callow said competing states have taken notice, adding that three governors courted his firm this week during the BIO International Convention in Boston. "Each wants to fly us to their state to talk turkey," he said.

There is little indication the local venture community will return to the high-water mark reached during the Internet bubble.

Massachusetts venture firms raised $3.3 billion via 13 venture funds last year, down slightly from the $4.1 billion collected in 2005. The slippage continued during the three months ended March 31, as local firms raised $1.4 billion, or $100 million less than in the same period last year.

At its peak in 2001, the local venture community launched 57 funds valued at $14.8 billion, according to research concern Dow Jones VentureOne.

Venture funds are typically structured with 10-year life spans, and the funds' partners have initial five-year windows to make investments. Once that cash is out the door, firms often go back to their limited partners to raise a new fund.

That so few firms have raised money since 2001 speaks to the sector's carnage after the Internet bubble burst. Indeed, many first-time venture funds folded before their 10 years were up, conceding that their portfolios were more or less worthless.

Other firms were never given a chance for redemption. For example, RSA Capital in Bedford, the venture arm of RSA Security Inc., had its funding pulled after a dismal run.

Likewise, at the former Boston office of POD Venture Partners Inc., a receptionist said Tuesday that the firm was recently "yanked to Sweden," home of POD Venture Partners AB, and was no longer operating in the U.S. The office's phones were disconnected a day later.

Peter Lawrence, an executive at cancer researcher Arqule Inc. in Woburn and a former POD partner, said the firm's backers, a wealthy Swedish family, wanted to focus more money on Nordic companies. He said the firm's first fund had "some successes."

Some firms appear to be mere operating shells without any cash to invest, while others have tried to reconfigure themselves to stay alive. On its Web site, Boston-based Cutlass Capital LLC says it has committed all of its 2001 $57 million fund and continues to "evaluate equity investment opportunities in companies at all stages."

But the firm has not raised a dollar in the years since. Calls to its offices in Boston and San Francisco were immediately directed to voicemail and not returned. Attempts to reach roughly a dozen other local firms resulted in similar results.

But there are still firms of that era with stories to tell. At CB Health Ventures in Boston, founder Rick Blume said the firm has split -- forming Excel Medical Ventures LLC in Boston and Health Enterprise Partners in New York -- due to the former partners' "different perceptions on where we should be putting our money." He said he hopes to follow up on CB's last fund, a $73 million partnership that closed in 2001, but did not elaborate.

Another local venture capitalist, who asked to remain anonymous, said his firm won an "extension" from its financiers to invest its 1999 maiden fund beyond the typical five-year horizon. With little dry powder left and a portfolio full of weak bubble-era companies, he said the firm is still holding out for a second fund. "We're still alive and kicking," he said, adding that "the attorneys" prevent him from talking about fundraising plans.