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Companies born in the recession
With a $400 million fund closed last week, Lexington-based Highland Capital Partners is betting that fewer companies will launch in the coming three years, and fewer billion-dollar companies will be founded. But General Partner Bob Higgins said he believes in a post-recessionary climate, the few great ones will have much bigger opportunities.
The $400 million fund is half the size of Highland’s last fund, closed in 2006. In April, Highland filed its plans to raise the smaller fund, and the long wait for a close led to some head-scratching among venture industry watchers. Fundraising has been difficult for venture firms as investors such as college endowments and pension funds scaled back commitments under financial duress. However, other well-established firms — Waltham-based Matrix Partners, for example — easily reached the bar set by previous funds.
“We just think it’s going to be a little bit of a slower time. Fewer really world-class companies will be started in this immediate post-recession period, so we don’t want to have too much capital,” Higgins said. “We had an unusually successful couple of years after the crash in 2000, 2001. Although there were fewer deals, there was really a scarcity of capital. And we think we’re going to see a similar environment.”
Higgins said Highland will cut its number of deals, its average deal size, and the duration of its eighth fund — investing closer to $125 million to $150 million a year over a three-year period, rather than $200 million a year over a four-year period. In Fund VII, Highland did about 15 deals a year. In Fund VIII, that number may be closer to 11, Higgins said.
Highland has also grown more wary of capital-intensive investments in biotech companies, said Higgins, who invests in health care companies. “I’d just as soon not state that we’re going to do less in biotech, but the capital efficiency in biotech is in question,” Higgins said.
Even as the IPO market appears to show a cyclical return, Higgins said that in the long-term, the bar has consistently gotten higher for biotech company exits. Now, before a biotech company can make an initial public offering, investors want to see Phase 3 trial data, he said. “I think we’ll do as much in health care, but I think our health care space will be a little more geared toward technology,” he said.
Venture limited partner Roland Reynolds, who manages the Alexandria, Va.-based venture fund of funds Industry Little Hawk LLC, says smaller funds are likely to outperform their larger brethren in returning money to limited-partner investors.
The IPO market’s current condition aside — since the 1980s, the long-term exit trend for venture-backed companies has been away from public markets and toward mergers and acquisitions, he said. In this decade, the average M&A exit has been $110 million.
“Small funds are the only ones that have a business model that supports putting a couple million dollars into capital-efficient businesses and garners ownership such that at exit, if it’s a $60 (million) to $80 million exit, investors should still be making four to five times their money,” Reynolds said.
On that thesis, Industry Little Hawk invests in funds much smaller than Highland’s — typically in the $100 million to $150 million range. The large funds of the world are “trending in the right direction” for better returns if they raise smaller funds, Reynolds said.
“It’s easier to generate multiples of capital with a smaller fund,” he said. “The question is, is $400 (million) small enough?”
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