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Institutional investor profile: Brad Kelly, Paul Fetsch, Paul Gompers and Joan Heidorn, general partners, Spur Capital

Kelly, Fetsch, Gompers and Heidorn on gaining access to the best venture funds, on the value of operating experience in a venture capital management team, on the need for patience and discipline when putting together a private equity portfolio and on Israel, the rising star of the global venture industry.

Spur Capital is a US-based fund of funds focussing exclusively on early-stage technology focussed venture capital investments. The firm invests predominantly in US venture funds, but also considers opportunities in Israel. The firm was founded in 2001 and raised its first fund in 2002 with $140m of commitments. Each of the general partners has between ten and fifteen years of experience in the venture industry.

What type of investments do you look for?
Kelly: 'We focus exclusively on early-stage technology focussed venture capital partnerships. We do not attempt to be a broad based fund of funds. We focus on what we believe to be, and what history has demonstrated to be, the most profitable sector of alternative asset investing.

'Obviously the most important thing that we look for in a venture fund is the ability to generate top quartile results. It is also nice to have some geographic diversification purely because it gives you access to a broader range of technologies. But ultimately we are looking for the best funds wherever they may be and we do not pursue geographic diversification for diversification's sake.'

Gompers: 'We primarily invest in venture groups that are in Silicon Valley or the Boston Route 128 area because this is where we have traditionally found the best opportunities. But it is important to note that Israel is increasingly standing out as a third hub of venture activity. Israel now has the framework of technologies, managers and support infrastructure that has the potential to grow and foster successful companies. There are definitely opportunities for Israeli funds to generate handsome risk adjusted returns at least as attractive as those generated in the US. Whether India emerges as the fourth key market remains to be seen.'

Fetsch: 'We predominately invest in IT focussed funds but we also have an approximate allocation of between 15 and 20 per cent for life sciences investment.'

What are you views on the US venture market at the moment?
Gompers: 'The catchword is cautious optimism and it is very important that we don't forget that caution in the near term. But nevertheless, in the meetings that we have with GPs and entrepreneurs it is clear that they are not only optimistic at the moment but that they are also seeing results. It is generally felt that the recovery in the technology markets has begun to take hold and I think that we are in for a sustained and a sustainable upward trend.'

Fetsch: 'It wasn't too long ago that you heard numerous pundits questioning whether all this spending on technology was actually going to have a measurable impact on productivity. I don't think there is any question any longer that the venture industry is going to be an enduring theme in the US economy.'

How do you go about putting a portfolio together?
Kelly: 'In order to ensure that you are invested in upper quartile funds on a reliable or consistent basis it is necessary to aim to invest in the top ten per cent of funds. This is why we kept the size of our fund of funds small. There is a universe of 200 to 300 venture firms that describe themselves as early-stage venture capital tech focussed, so logically there are between 20 and 30 in the top ten per cent. It is therefore our strategy to invest in about 18 to 21 relationships. If we were going to invest in many more relationships I would start to question whether we could reliably hit the top 10 per cent, which will, fund over fund, generate with some kind of consistency, top quartile results.

'We also like to make sure that our investment horizon parallels the investment cycle, the timeframe in which we would expect all venture firms to come back into the market place. In this way we ensure that we are able to make our selections from the universe of what is available not just the universe of what is available today. This is why we like to construct each portfolio over multiple vintages. It also has the effect of giving us a broader window over the development of new technologies and therefore provides more balance to the portfolio.'

How do you find out about good funds?
Kelly: 'It is a very proactive process. It would be a rare exception if the first that we heard of a fund was a PPM landing on our desk. We have all had ten to 15 years of experience investing in venture so we have a considerable knowledge pool and contact base. It is then a case of one name leading to another.

'We are also constantly looking for the emergence of new talent in the market place. Whenever we start hearing a name repetitively we look to find out more about them. We don't await their next fundraising, but rather try and seek them out proactively.'

How would you describe your appetite for first time funds?
Kelly: I would say that it's healthy in that we have an aggressive interest in learning about funds that have the potential to be top tier, regardless of how new they are. Having said that, we don't invest in many. We are only looking to invest in 20 funds and of those approximately three quarters are likely to come from historic relationships. But nevertheless we are aggressive in seeking out the few that meet our standards.'

Heidorn: 'The venture capital industry has often been characterised in the past by firms splintering and reforming with different aggregations and what you need to do is follow the talent. We are always particularly keen to familiarise ourselves with seasoned venture capitalists that have reformed in new groups. We may not invest with them as a first time opportunity but we will keep a very watchful eye over them to see how they construct their new firm, how they operate, and how they might fit in as part of our long-term strategy.'

How difficult is it to gain access to the best venture funds?
Kelly: 'Accessing the premier partnerships is as difficult as I have ever known it in 15 years of partnership investing. I think this is because the market has gained a somewhat belated appreciation of the importance of investing with the very best. What this means is that the top tier general partners are in a position to pick and choose who they would like as limited partners.'

Gompers: 'It is certainly becoming increasingly difficult to get into the top quartile funds, and that is where the six decades of experience that we have in the industry helps. We are not faddish investors and we can bring something to the table besides money.'

Fetsch: 'I think it's clear that the venture capital community is becoming increasingly discriminating regarding who they want as investors in their funds. GPs are looking beyond the depth of an LP's pockets or whether they have invested in the past. Firms are now looking for investors with whom they share an investment philosophy. They are looking for user-friendly limited partners.'

What do you look for in a private equity manager?
Heidorn: 'The main quality that we look for in a management team is deep operating experience. We like to see GPs that have been founders of technology companies and that have demonstrable expertise in the specific technologies in which the team is looking to invest. We also look for a cohesive team with an effective decision making process. It is important that the team is not clouded by succession issues. We are also looking for teams with a track record over both good and bad times.'

Kelly: 'We strongly believe that a firm needs to be governed by an effective and collective decision making process. The type of propositions that we would shy away from would be where one person dominates. If everybody is afraid to point out that the emperor is wearing no clothes that can lead to monumental mistakes.'

What advice would you give a new investor in private equity?
Fetsch: 'First and foremost I would say have patience. To reach your intended allocation in the asset class takes a good deal of time and forethought. If you proceed slowly, methodically and with patience, you will end up with a very satisfying portfolio. But if you respond reactively to the opportunities in the market rather than cautiously and proactively, I think you are going to be very disappointed by the opportunities that present themselves.'

Kelly: 'In venture capital you should probably try and move towards your optimal target over a five to six year period of time as opposed to public equities where you can be there tomorrow. If you do build up slowly over this type of time horizon, your original investments, with any luck, will have started to throw off cash. From then on the process becomes more or less self-perpetuating. If you take the alternative approach of racing to get to your target you are likely to fall back into the pig in a python dilemma where you have a digestion problem. You will have invested all of your target allocation and will be left waiting for it to mature. In the process of waiting you may miss out on what could be some very good vintages.'

Gompers: 'Discipline is also absolutely essential. You may never reach your target allocation because you simply may not be able to find enough quality opportunities. Asset allocation models are all well and good but unless you can find the opportunities you may have to live with not being able to get all the money into the asset class that you would like. So it's a question of patience with discipline.'

What do you think is the biggest challenge in the private equity industry at the moment?
Gompers: 'I think as the market is beginning to recover the challenge is to temper the urge to invest excessively into the asset class. It is important that investments are made in a measured and disciplined manner because there are clearly groups out there which should not be funded. In the late 1990s and 2000, there was a tendency to invest almost indiscriminately and that is the biggest potential risk that investors are faced with today.'

How do you think the venture market will evolve going into the future?
Kelly: 'I think the market will continue to bifurcate and the dispersion of results in the sector, which are already wider than in any other investment sector, will widen even further. There will be a further pulling away of the really quality firms from the rest of the pack.'

Fetsch: 'I also think that there will be a number of new venture groups, which are able to establish themselves in the market and may even break through into the top quartile. There may also be other groups which have been around for a while, which will stumble and lose their way. But certainly the gulf that exists between the top quality company building groups that can generate tremendous returns and groups that both have trouble raising capital and find it difficult to attract the best entrepreneurs will continue to grow.'

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