What Capital Crunch?

Despite the turmoil in housing and the stock market, big investors continue to pump money into venture capital

There's no capital crunch in Silicon Valley.

Despite turmoil in the stock market, jitters about mortgage financiers Fannie Mae (FNM) and Freddie Mac (FRE), and the worst market for initial public offerings in decades, big investors continue to pour money into venture capital funds.

Some 71 venture capital funds raised $9.1 billion in the second quarter of 2008, up 3% from the year-ago quarter, according to a survey released July 14 by Thomson Reuters (TRI) and the National Venture Capital Assn. Investments in information technology, life sciences, and environmental technologies continue to drive the market. As the venture capital market becomes more global, Asia is emerging as an attractive location for investments.

The latest numbers signal that big investors are confident in the long-term future of the venture capital business. There does seem to be a flight to quality, however. The number of funds raised in the quarter fell 14%, down from 83 in the year-ago period.

That flight is evident in the fund-raising tables. Older firms with longer track records raised the largest amount of money. Lightspeed Venture Partners, an eight-year-old Silicon Valley firm that has backed Blue Nile (NILE) and Transmeta (TMTA) among others, raised the single largest fund, at $800 million. Kleiner Perkins Caufield & Byers, which has financed Google (GOOG), Intuit (INTU), and Amazon.com (AMZN), raised $700 million for investments in startups, and another $500 million fund to invest exclusively in later-stage companies formed to help solve climate problems.

And Foundation Capital, a 16-year-old Silicon Valley venture firm that has funded Netflix (NFLX) and a number of clean technology startups, boasted the second-largest fund at $750 million. The fund will set aside $250 million to expand the firm's practice in environmental investing. "There is so much money out there," says Adam Grosser, general partner of Foundation. "The scarier metrics for me is that most things get funded."

Investing in Asia

A lot of that money is being funneled into Asia, primarily China and India. The Carlyle Group recently closed its fourth Asian Growth Fund for $650 million. That fund will plow money into more mature and growing private companies looking to expand in China, India, Japan, and Korea. Another big player, Intel Capital (INTC), the venture capital arm of the giant chipmaker, closed a $500 million fund to invest in Chinese wireless broadband, media, telecommunications, and green technologies. Intel Capital's first China fund, a $200 million fund raised in 2005, has already been fully invested in 28 companies, including Neusoft Group, A8 Music, and Palm Commerce.

The most successful firms are raising more money than they expected or turning away money from their limited partners, says Grosser and other VCs. Lightspeed, for example, says it sought to raise $675 million, but ended up netting an additional $125 million. "We had access to more than that," says Chris Schaepe, managing director of Lightspeed. "Each of our funds is a top-quartile performer."

After Foundation Capital announced its intention to raise a new fund, Grosser says, the fund was "dramatically oversubscribed" within hours. Foundation raises money from the firm's 28 limited partners, which include large university endowments and foundations such as Harvard University, the Rockefeller Foundation, and the MacArthur Foundation. To deal with the unexpected demand, the firm had to raise the allocations for some limited partners while reducing the stakes of others, Grosser says. "On the one hand, [limited partners] say there is too much money out there," he says. "But at the same time they want you to take all of their money."

Spreading Their Bets

Some of the biggest limited partners are spreading their bets, investing in many types of funds. Brandon Park, senior vice-president of Pacific Corporate Group Asset Management, which manages $15 billion for the California Public Employees' Retirement System and other large state pension funds, says over the last few years his firm has invested about $2 billion in 50 venture funds, including Technology Crossover Ventures, Oak Investment Partners, and 406 Ventures.

Sure, Park admits the doldrums in the IPO market have forced him to reduce his expectations for the VC industry. In the second quarter of 2008, there were no venture-backed IPOs in the U.S. stock market, the first time an entire quarter has passed without a venture IPO since 1978. But rather than trying to time the market, Park says, his clients are confident venture capital returns will remain strong over the long term. "It will continue to be a healthy portion of our clients' portfolio," says Park. In fact, he says, some clients are trying to increase their exposure to private equity. "We are extremely active in this space," says Park.

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