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Institutional investor profile: Jason Andris, Principal, Venture Investment Associates

Andris on the opportunities in the US venture capital market, on the lack of opportunities in the secondaries space, on the dangers of constantly re-upping, on GP hubris and on the short-sightedness of punitive terms and conditions.

Venture Investment Associates is a private equity fund of funds group based in New Jersey. It was formed in 1993 through a spin-out of the private equity fund interests of the American Express Company. The firm currently manages $750m across five funds, which invest in buy-out, venture capital and growth capital funds as well as in some secondary transactions. Andris joined Venture Investment Associates in 2000. He started his career as an investment banker at Robertson Stephens & Co and then joined the management team of  a venture-backed company he helped take public.

What type of investments do you look for?
‘We invest primarily in early-stage venture capital funds, although we do also commit to buy-out and growth capital groups. We have a very limited number of commitments to groups that invest internationally; we are mainly focused on the US.'

How do you put together a portfolio?
‘We are opportunistic in our approach and so we don't really have set allocations for particular parts of the market. I know that a number of groups, including funds of funds, have allocations to particular sectors of the market. They tend to think of private equity as its own industry. But we look for groups that are able to produce extraordinary returns. We are not interested in achieving the median performance.

The majority of our investments are with groups that we have known for a long time - groups that we know and trust. Our strategy is very much relationship-driven. American Express was investing back in the 1970s and 1980s and many of the relationships our founder formed while building that portfolio have endured with our firm to the present day. We were the lead investor in some of the most established groups in the US and we helped them get off the ground and develop. As a result, we are very close to the managers.

‘That is the philosophy driving our own fundraising process. We don't raise large sums of money even though we can. We look closely at the investments we expect to make among our existing relationships and accordingly, we know what size fund will be appropriate and when we will need to raise it.

‘Having said that, we do reserve a small amount - something in the region of 15 per cent to 20 per cent - to invest in groups that we have not committed to before. We recognise that some of our relationships will not last forever and that we have to keep our pipeline full of new prospects. Some of our new relationships may be more established groups that we have not previously had the opportunity to get to know, some are spin-out groups and others are newer groups. We invest smaller amounts with these groups with the intention of watching how they work. You only know how they really operate once you have invested capital with them. From these small commitments, we hope to build long-term relationships and, perhaps, increase our allocation to them over time.

‘So the investments that we make are driven by our network and relationships with the sole objective of being with the top managers - something you can only really do with years of experience.'

What type of secondary transactions do you look at?
‘We were born out of a secondary transaction and so it is natural that we look at this area of the market. But we are different from many secondary buyers in that we are more comfortable with taking manager risk and are less so with investment risk. Many secondary buyers like to see more than 50 per cent of the capital drawn down if they are looking to acquire an interest, whereas we are the opposite. We would look at less mature portfolios because we view our strength as choosing good managers  rather than trying to estimate where an investment that has already been made will come out. We also more often buy secondary positions in funds that we have committed to, so we already know the managers well. It would be very difficult for us to get up to speed with managers that we have never encountered before.

‘We source our secondary deals through our network of GP relationships, brokers and other LPs.'

How would you rate the quality of deals on the secondary market recently?
‘The secondary market has been very active of late, but there have been very few that we have found attractive. There were a number of institutions and individuals that came into private equity in the late 1990s - those are the ones more often than not that are looking to exit. There are also many investors that increased their allocations to a level that they have since discovered was not appropriate. In both cases, these investors tend to be less sophisticated in their manager selection and are not necessarily in funds that we would consider to be in the top tier. It is, after all, very difficult to establish relationships with top-tier managers and gain access to their funds. Accordingly, you are not going to see many secondary positions in the best funds up for sale.'

Do you make co-investments?
‘We do not make co-investments. We believe that there are certain people who are best suited to investing in venture capital or in buy-outs and some to making fund investments. We don't believe that the people in our organisation have the necessary time or skills to invest directly in companies. We wouldn't be able, for example, to make a meaningful impact on an early-stage company and help it develop. I wouldn't want to put my capital or the capital entrusted to me by our limited partners into an area in which I am not sure that I would be able to deliver the very best performance. We look for people who can do it for us. Our skill set is in selecting managers and therefore that is our focus.'

Why do you focus on early-stage investments?
‘Our focus on early-stage funds is partly a function of the relationships that were built early on in the portfolio, when it was owned by American Express but, more importantly, it is also a result of our belief that the risk-reward profile of venture capital is much more favourable than that for later stages of private equity. When they have the right technical understanding and operating experience, early-stage venture capitalists have the ability to affect their investments more meaningfully and therefore to produce extraordinary returns.'

What's your view on the current state of affairs in the early-stage market?
‘The early-stage market offers some very good opportunities right now. The bubble of the late 1990s has now burst - in fact, we expected it to burst much sooner than it did. That period was frustrating for us because we realised that it was an unsustainable situation. The market is now left with an overhang, which is working its way through the system. But I think that money will be lost - much of it was dumb capital. A lot of people simply poured money into the market, thinking that investing was a lot easier than it is. Capital was easy to come by in the late 1990s, which attracted a lot of unsophisticated general partners. Many thought that they could scale the business or just replicate what others were already doing. A lot of these groups have been spooked by the downturn or have been flushed out of the system.

‘As a result of this clean-up, the managers we work with are finding that there is far less competition for deals, there are fewer groups that are willing to stick their toe in the water and valuations have come down. Costs have also reduced dramatically for management and space, etc. It's now easier to build a team and a firm, you're doing so at better valuations with more reasonable business plans and lower burn rates. We are witnessing a return to a framework that can yield high returns; when there was an extraordinary amount of money going into these businesses, you needed an exceptionally frothy exit environment to achieve any sort of return. I'm very optimistic about the potential for this area of the market.'

What do you look for in a private equity manager?
‘One of the most important factors we look for is a track record of success, plus a number of attributes that we believe determine that success - technical experience, business experience, an ability to mentor the management of portfolio companies and the capacity to have a positive impact on the business.

‘There are also some qualities that are harder to measure, but equally important: an impeccable character, a cohesive partnership, alignment of interest with the LPs, for example. We also want to see managers that are willing to contribute some of their capital beyond the standard one per cent. That demonstrates a level of commitment to me. After all, that's what we do. The employees of our firm are among our funds' largest investors. We take the view that we are not just deploying capital - we are principals rather than just agents.'

What puts you off a fund?
‘GP hubris is a real negative. It's a very frustrating feature of the market. As recently as last fall, we saw groups coming to us with unreasonable expectations about fund size and half-baked plans as to why they needed such a large sum of money - every partner needed “x” amount, for example. These plans were totally unrelated to investment opportunities.

‘We are also put off by groups that have imposed punitive terms in the past. Groups that felt it was acceptable to switch to a carried interest split greater than 20 per cent or that raised as much as they could and that added amendments after final close allowing them to reopen the fund because someone wanted to offer them more money - we saw all of these and we find them less compelling now. This type of behaviour was driven by greed and is indicative of people who do not view the GP-LP relationship as a partnership of equals. It also shows a lack of understanding about the way this business works. Private equity is cyclical. When times are good, it is inappropriate to shove unfavourable terms down limited partners' throats. It is a short-term view and is damaging over the longer term.

‘We are not interested in groups that see it as their role to raise funds rather than build companies.

‘One of the reasons we have seen all this happen is that there was a flood of capital into the market, and that is frustrating. This will all work through the system eventually, but there will be a lot of fall-out along the way.'

How do you think this will affect the industry over the longer term?
‘I think one of the lasting impacts of this culture of greed is that many funds brought on a lot of inexperienced people to make their teams seem fuller. As a result, there are some people making investments that may not have the ability to be proper stewards of their capital or to track their investments in the way that they should. Instead, they are taking the stock market approach of taking passive bets on investments and hoping for success. That style of investment tends not to work in the private market.

‘What is troubling now is that some GPs have done so well that they are no longer engaged in the day-to-day business of their funds - that is left to the less experienced members of their team.'

How concerned are you about succession?
‘Succession is an issue when it relates to the fact that there was a lot of money raised by a certain set of individuals but that is now being invested by another. But it is not so much of an issue when you are talking about a natural progression. Some groups that have done well in the past may not transition well. That is to be expected. I view it as an element of risk, but with risk, you also have opportunity. You will find instances in which people feel they are not treated well enough in their existing firm and then spin out. If they have a proven track record, then it can provide a tremendous opportunity for themselves and the investors that choose to support them.

‘This is why LPs must remain on their toes and not constantly re-up on their funds. The firms they are investing with may have a great history, but today's managers may have nothing to do with the historical record.'

How do you think that the market will change in the future?
‘We are already seeing signs that some firms and, indeed, some sectors are moving towards a money-management style of business. There are certain sources of capital that have allocations to private equity, need to be able to make significant investments and want to invest with an established organisation. Some players have grown their business to serve that capital. We saw it first in the buy-out area and we are starting to see it in venture capital now. That progression towards money-management will continue for some groups.

‘I think - and I also hope - that there will continue to be managers that are driven by a thirst for working with entrepreneurs and building great companies. That strategy doesn't fit with having a great deal of capital under management. These will be smaller, focused funds that maintain their discipline and that have the ability to generate extraordinary returns. A GP must decide whether he/she is in the business of building great companies, ergo capital gains, or in the business of fundraising.'

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