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The Dealmakers - Terence O'Hara

New Enterprise Is Huge and Proud of It

By Terence O'Hara
Monday, December 6, 2004; Page E01

Peter J. Barris runs the biggest stand-alone venture capital operation in the world. His firm, New Enterprise Associates, sailed through 2002-03, the nuclear winter of venture investing, with relative ease. Nearly every technology entrepreneur worth his salt would put NEA near the top of his list of firms he'd most like to raise money from.

Yet Barris and other longtime NEA partners continue to hear criticism from within their industry that NEA's girth is a handicap, that NEA has strayed from the one true swashbuckling venture capital faith and become -- institutional.

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Venture Capital Section

Barris has heard this criticism -- that NEA is too big and spread out to create the home-run investments that put managers of NEA's more romantic, smaller rivals on the cover of business magazines. He has a well-practiced response.

"I understand the question, or the criticism, at a philosophical level," Barris said last week. "But the empirical data don't support it. The numbers don't lie."

Barris, who is based in Reston, became the Baltimore firm's sole managing general partner in 1999 after serving three years as part of a management troika. Since then, NEA has indeed performed better than the vast majority of venture capital firms, although not at the level of the highest-performing firms that manage much smaller amounts of money.

"I would argue that size is an advantage," he said. "We have a superior network of entrepreneurs that have done business with us for years. We have the capital to see an investment all the way through. We have the domain knowledge to match any fund. And we have a presence on both coasts."

"And," he said, "we perform."

NEA has 11 venture funds, three of them raised since 1999. None of the three funds was in the black at mid-year. According to the California Public Employees' Retirement System (Calpers), which invested in the 1999 fund NEA IX and 2000's NEA X, those funds had an annualized internal rate of return of minus 24 percent and minus 0.9 percent, respectively, on June 30. Those numbers may not prove much, however: It's a rare fund from those years that has a positive return, and there is ample time in which to realize a profit, which could be substantial. It takes up to 10 years to determine a venture fund's final rate of return.

NEA IX is far and away NEA's worst performer. "Not our most proud fund," Barris said. NEA IX had 90 percent of its capital in technology firms, mostly telecom-related investments, Barris said. For early-stage 1999 funds like NEA IX, break-even is considered excellent.

NEA X, the firm' s biggest, is performing substantially better than 75 percent of all other funds raised in 2000. Barris said that since June 30, it has moved into positive territory.

Discussions with NEA limited partners -- institutions and rich people who invest in NEA's funds -- and others in the industry who follow NEA closely reveal a common theme: NEA has become a better-than-average venture shop, and is now big enough so that description means real money. On average, its portfolio companies have a better chance of returning money to NEA's investors than portfolio companies of other firms. On average, it's as good a bet as any for an investor who wants to play in venture capital. And for institutional investors such as Calpers and other big money managers, that's as good as it gets. They've thrown money at NEA in the past four years.

"Their structure enables them to handle large amounts of money," said Edward J. Mathias, a managing director in Carlyle Group's venture capital business who helped NEA's founders when they started the firm in 1978. "An institutional investor wanting to invest $25 million can do so with NEA with some assurance that they can have above-average -- not hugely above-average -- but above-average returns. They have a high batting average. They hit a lot of doubles instead of a few home runs."

That may sound like feint praise, but Mathias is a staunch admirer of NEA and its people. Hitting a lot of doubles in venture capital is no easy feat, he said.

Not everyone is as big a fan. Steve Lisson, the editor of InsiderVC.com, takes a dim view of NEA's size.

"Larger funds can't produce the kinds of returns of smaller funds," said Lisson, whose company provides analysis of and statistics on venture fund performance and management practices. "Returns vary inversely with money under management, because the larger the fund, the less impact one monster hit will have on its performance."

NEA X is the largest VC fund ever. It raised $2.3 billion from its limited partners in 2000. The firm's latest fund, NEA XI, stopped raising money a year ago at $1.1 billion. Most of the largest non-NEA early-stage venture funds max out at $350 million, and some more prominent venture capital firms would not know what to do with that much. Novak Biddle Venture Partners, a Bethesda firm that has probably had the most successful run of any local venture firm in 2004, raised a $150 million fund this year, then turned investors away. Novak Biddle Partners III, a relatively small fund raised at roughly the same time as NEA X, was up about 6 percent as of Sept. 30.

Managers of funds the size of NEA's, Lisson said, inevitably have to do more later-stage and follow-on deals because the universe of the best early-stage deals, which provide the biggest risk-return, is necessarily finite. The most profitable funds are the ones that focus solely on the earliest-stage companies, and spend lots of time and money on those companies at their birth, Lisson said. If NEA invested all of the $1.1 billion in NEA XI in such small, time-consuming investments, it would need a heck of a lot more people than the 37 partners, venture partners and principals it has now.

To take an extreme example, think of Google Inc., whose early venture backers made billions of dollars when the company went public this year. NEA has financed more than 370 companies, and has a lot of big winners in its huge portfolio, but none would compare with Google.

Barris disputes the notion that NEA is forced to do more later-stage, less-profitable deals. "As our funds have increased in size, the percentage of early-stage, start-up deals as a percent of our total has grown, not shrunk," he said.

Institutional investors are more than comfortable putting money into NEA. Its performance, they say, is not tied to one deal, and the firm's track record over more than two decades speaks for itself. NEA's first eight funds, the last of which closed in 1998, have made huge amounts of money. NEA VIII, a $560 million fund, earned an annualized internal rate of return of 168 percent.

Barris said NEA's cost structure is distinctive in several ways. Most venture capital fund managers charge a percentage of the fund's size to cover their expenses, typically 2 percent of a fund's capital. NEA doesn't do that; instead, it a budget of expenses expected to cover the costs of running the fund, including salaries, that are then approved by a representative board of limited partners. For a large fund, that sharply reduces the costs to the limited partners.

"Limited partners love this," Mathias said.

Calpers, one of the most active investors in private equity funds, committed $75 million to NEA X, one of the 10 largest investments it has made in a single venture fund.

Most venture funds split the profits of a fund, the most typical split being 80 percent going to limited partners and 20 percent going to the fund's managers. NEA, Barris said, makes the split 70-30.

Inside the firm, profits from a deal are spread out across the partnership; no one partner takes more than another in a single deal. That promotes a team atmosphere that is necessary in running a big fund, Barris said. In most funds, a partner who leads a successful deal gets a bigger cut of the profits than other partners.

The result, Mathias said, is less the amalgam of egotists seen at many venture capital firms than a consortium of super-smart people trying to make a lot of money. "It's not a superstar kind of firm," he said.

Although NEA has more money under management than any other stand-alone venture capital firm -- some Wall Street private equity firms that do venture investing have bigger funds, but tend to engage as well in leveraged buyouts and hedge investing -- Barris said there's no prospect for his firm becoming dominant in the venture capital world.

"The industry has just gotten more competitive, not less," Barris said. "Even with our huge funds, we still have only 2 percent of the total amount of VC funds under management. In this business, it's not who has the most money but who has the most expertise that matters."

And is NEA an "institution," that staid word that makes many small venture capital firms shudder?

"I don't know what the definition of institutional is," Barris said. "I think we've gone farther than most firms in institutionalizing what has been a cottage industry. We employ some professional management techniques and policies. But because we started the firm on both coasts, we've had those things from the beginning. So I don't think we've changed much as we've gotten bigger."

Terence O'Hara's e-mail address is oharat@washpost.com.

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