Most venture capitalists have hordes of entrepreneurs clamoring for a few moments of their time. Jonathan Meeks prizes his list of people who don't want to take his calls.
Meeks, then a vice president with TA Associates, first rang Sunil Hirani, cofounder of the New York electronic derivatives broker Creditex, in 2003. The former NASA software guru firmly told Meeks that his four-year-old firm was profitable, growing and didn't need his money. For three years Meeks logged monthly calls to Hirani, quizzing him on the economics of brokerage firms and swapping industry gossip.
When another Creditex cofounder needed to sell his stake, Hirani ushered the deal to Meeks, who bought 50 per cent of the firm for $57 million. Last June, five years after Meeks' first call, he got his reward: Intercontinental Exchange paid $650 million for Creditex, earning Meeks four times his investment and launching him to number 83 on the Forbes Midas List of tech dealmakers.
A few years ago merely quadrupling an investment over five years wouldn't have given you anything to brag about in the exclusive club on Sand Hill Road. John Doerr of Kleiner Perkins Caufield & Byers and Michael Moritz of Sequoia Capital (numbers one and two on this year's list) earned hundreds of times their money by putting it into Google and Yahoo when those firms were barely business plans.
Now Meeks' game--investing in adolescent companies whose managers have already figured out how to turn a profit--looks like the smartest strategy in town. "Returns don't come from being the gray-haired coach and building companies from scratch,'' Meeks says.
Over the past five years early-stage investments have given VCs' limited partners a return of five per cent, roughly the same payout as a Treasury bond index. Late-stage deals have returned 12 per cent, according to the National Venture Capital Association.
The recent collapse of the new-issues market, where early-stage VCs have historically notched their biggest wins, has made things even worse. Many VCs and some limited partners are now wondering whether the early-stage investing model is permanently broken. They are moving on from acorns to saplings--what are called "growth equity" investments.
The dollars in play in growth equity have, of course, been smaller. In 2006 half of all the venture money raised, $15.7 billion, was put into funds doing only early-stage investing. Only 8 per cent, or $2.6 billion, was earmarked for exclusively late-stage vehicles.
But the slow yet steady returns of growth equity firms are attracting competition from the players of startup lotto. In 2007 and 2008 VCs raised $15 billion for late-stage venture funds, double the amount in the previous two years and 25 per cent of the total take for all venture funds.
Don't expect the superior returns to last, however. "When everyone is rushing in to the same space, prices on deals will get bid up and returns will fall," warns August Capital's Howard Hartenbaum, an exclusively early-stage investor and number 13 on the Midas List.
Switching from early- to late-stage investing also means a big change in attitude: Venture capitalists must adopt the bullheadedness of a fullback rather than the flashiness of a star quarterback. "Most of these new entrants have no business doing growth deals," scoffs Douglas Leone, a partner at early-stage juggernaut Sequoia Capital and number 39 on this year's list, who helped his firm muscle into growth-equity investing in the 1980s.
Growth deals are heftier--$9 million on average, but occasionally reaching more than $100 million, compared with seed investments of $1 million to $5 million. The targeted returns are more plodding--three to five times--and the expected success rate is higher, perhaps three in four rather than three in ten.
"In the venture business you have a lot of people who are artistes who do things to create a business," says number 42 Midas lister Bruce Evans, managing director at Summit Partners and growth-equity backer of OptionsXpress, which now has a market cap of $700 million. "We're investors and salesman first."
Meeks learned the humility and number-crunching ethic of growth investing during his 20s as a junior employee at TA Associates in Boston. He spent 13 hours a day scouring trade journals and databases for potential deals, cold-calling chief executives and drafting deal memos.
The template that Meeks followed dates back to 1968, when Peter Brooke, a partner at Boston investment bank Tucker Anthony, started an internal venture fund to compete with the dominant early-stage investors of the time: the investment offices of wealthy families such as the Phippses (Bessemer Securities) and the Rockefellers (Venrock). Among Brooke's early hires was C. Kevin Landry, then a recent Wharton School M.B.A. who had helped pay for his education by driving a cab.
Landry (now number 29 on the Midas List) had deal hunters like Meeks looking for fast-growing, young tech companies. The diggers called those firms' founders and tried to glean bits of data about the firm's industry and finances. These days 30 associates call about 5,000 companies a year. That information along with extensive databases gets poured into a collection that now includes statistics on 350,000 privately held companies.
Companies are categorized as unsuitable targets, interesting but too young, or potential investments. Associates are compensated, in part, based on the number of companies they convince to meet with ta. When a company is denoted as a possible investment, TA sends out two partners to scrutinize the firm's operations. TA visits approximately 1,200 firms per year and invests in 10 to 12.