MINNEAPOLIS - Norwest Venture Capital is on a roll.
In 1994 it invested a record $75 million in fledgling entrepreneurial enterprises while contributing $77 million in pretax capital gains to Norwest Corp.'s balance sheet.
Early this year it launched the fifth fund in its 24-year history: the $200 million Norwest Equity Partners V.
The unit followed that launch with another $42 million in investments during the first five months of this year.
Daniel Haggerty, the unit's CEO and general managing partner, says there appear to be few troubled spots on the horizon - a rare feat in the venture capital business, where upward of 30% of the companies invested in typically fail within the first few years.
"They're a top-notch venture capital firm with top-notch partners who have experience and know what they're doing," says Timothy Clayton, an audit partner with Price Waterhouse LLP.
About 20 banks are active in the venture capital field. Figures compiled by The Private Equity Analyst, a Boston-based newsletter, show that Norwest Venture Capital is the fourth-largest bank-affiliated venture capital unit, behind Chemical Venture Partners, BankAmerica Capital Corp., and J.P. Morgan Capital Corp.
Between 1980 and 1993, bank venture capital arms invested nearly $5 billion in about 1,500 companies - or about 15% of all venture capital invested - according to the newsletter's editor Steven Galante. Internal rates of return on those investments averaged 25.9%.
But Norwest's unit, with $900 million in capital, makes it the only bank active in early-stage investing; a whopping two-thirds of the unit's investments go this high-risk, high-return market. Other banks focus on backing safer late-stage investments and management-led buyouts.
"Norwest is unique among banks in its decision to focus on early-stage investments," says Mr. Galante. "They do true venture capital."
It's a risky business, but Norwest does it well, largely because of its ability to retain its cadre of experienced partners with compensation packages that rival those of independent venture capital firms and beat those offered by other banks.
Such packages typically include a base salary plus a hefty share of the profit from any deal in which the individual partner is involved.
"In this business, everything comes down to the team you have assembled, and the knowledge they possess," Mr. Galante says. "Most banks haven't been able to build compensation structures that are as rewarding to the partners as doing it independently."
Hanging onto good partners is especially vital with early-stage investments, which often are based on nothing more than an idea. Their potential for failure scares away many banks, and it takes in-depth knowledge of the markets and players to make a deal work.
"You have to have an appetite for volatile performance to invest in start-ups, and most banks don't," says John Whaley, a Norwest partner who specializes in technology start-ups.
Norwest is firmly committed to the business. It has about a dozen partners and offices on the East and West coasts.
"It's a natural extension of our focus on expanding the diversity of our earning stream," says Norwest Corp.'s CEO, Richard Kovacevich.
Investing in start-ups has side benefits. Among these are boosting Norwest's profile as a full-service business bank whose investments help create jobs, and fostering relationships that result in loyal customers.
"It helps our image as being a financial services institution that runs the gamut, supporting start-up companies and mature businesses," Mr. Kovacevich says.
Mr. Haggerty's operation was founded in the early-1960s by Norwest's predecessor, Northwestern National Bank, as a small-business investment company. It hit rough times almost immediately.
Within a few years a group of Twin Cities businessmen jumped in to rescue it, leaving the bank with a one-third stake in the enterprise. By the late-1970s the business had grown, and many of those businessmen wanted out. Norwest slowly acquired their stakes; today it is the sole owner and investor.
The relationship between Mr. Haggerty's team and the holding company, officials say, is mutually beneficial.
The profits earned by the unit are on par with the industry average. Overall, venture capital units contribute a substantial 6% to the earnings of banks that have them, while eating up only 0.33% of assets, Mr. Galante says.
The holding company's funding gives Norwest Venture Capital a big advantage over its independent rivals. It doesn't have to spend time raising funds, and can therefore focus its energies on the investment side of the business.
"They are given complete autonomy," says Mr. Kovacevich. He said he meets with Mr. Haggerty about once a month.
In the first quarter of this year, Norwest completed more deals than any of the nation's other top 10 private equity investors, pumping $19.3 million into 16 companies, for an average investment of $1.2 million.
In contrast, NationsBanc Capital Corp. pumped $22 million into four companies - an average of $5.5 million per investment - according to the a tracking survey conducted by Price Waterhouse.
Though the risks of early-stage investing are high, the base rules are simple: Take equity stakes in small, private companies with good ideas and management, but little money. Aim for compound rates of return in excess of 20%, mostly to be realized through an initial public offering or acquisition five years or so after the initial investment.
It's a high-stakes game that requires patience, resolve, and a bit of luck. For Norwest, picking winners from the fledgling businesses that knock on its door each year can be both exhilarating and daunting.
Norwest officials credit their success to hard work and a sharp focus on a handful of well-defined investment niches - software, consumer goods, and medical services - where they know the markets and players.
"All deals boil down to three things: management, the product's market fit, and whether the deal is priced properly so that if it is successful you get an appropriate rate of return," Mr. Whaley says.
The biggest wild card is the managers. Sizing them up is more art than science, Mr. Whaley says. Norwest considers more than 1,000 financing proposals per year, but actually invests in about 20.
The company researches managers' pasts, "but it still doesn't tell you a whole lot," Mr. Haggerty adds. "We've had success with people who've been failures in the past, and vice versa." Norwest's list of investments and liquidations illustrates the hazards and opportunities in the venture capital world.
In 1980 it invested in the start-up of Vee Corp. which produces touring "Sesame Street" stage shows. Uncharacteristically, Norwest remains an active equity holder.
"It's a very mature relationship," says Nick LaFontaine, Vee's finance vice president. "They are active but not invasive."
The Norwest unit holds equity stakes in about 25 software firms, each with a different market niche. "We probably don't have two companies in our software portfolio that are directly competitive," Mr. Haggerty says.
But even the best research can result in flops, and venture capitalists must always be ready to accept that today's promising investment will be tomorrow's writeoff.
Mr. Haggerty tells the 10-year-old story of Norwest's $8 million investment in a computer workstation maker who seemed to have a lock on the market. "The technology changed, and the company's product didn't fit the way the industry evolved," he recalls.
Venture capital investments also are vulnerable to the vagaries of public markets, the economy, and capital gains tax policies.
All these have been positive in the 1990s, but Norwest officials still estimate that out of every 10 investments, three are losers and six just break even.
Mr. Engen is a freelance writer based in Minneapolis.
