SAN FRANCISCO - Until recently, Silicon Valley's venture capital firms followed a logic similar to the one that drove the megabank mergers of the last two years: Bigger is almost always better.
That meant the size of their new investment funds, which feed capital-hungry young firms, had been reaching ever skyward. Thomson Financial Venture Economics estimates that funds that started accepting money in 1999 were an average of 33% larger than funds raised in 1998. It was not surprising to see these investment pools come close to or even break the $1 billion mark.
But some newer funds, including a few that are in the planning, are bucking that trend. Observers said that if the fund size ceiling starts to shrink, at a certain point start-up companies in need of fresh capital could find the well has gone dry.
Case in point: San Francisco-based merchant bank Thomas Weisel Partners is planning to start raising a fund of approximately $250 million in the next four weeks. The fund, which is far smaller than the $1.3 billion fund Weisel already manages, will focus on investing in early stage technology companies, said Derek Lemke-von Ammon, co-director of private equity at Weisel Partners. The smaller fund will be called Thomas Weisel Venture Partners.
The rationale the firm is using is a familiar one in banking: As other firms go after larger deals, the door opens for someone to take the smaller ones. While other venture capital funds get bigger, "we see some opportunity," said Mr. Lemke-von Ammon.
There is also a practical reason behind the fund's size. Weisel Partners, which was founded in early 1999 by Thomas Weisel, the former head of Montgomery Securities who left when that company was acquired by Bank of America, doesn't want it to compete with the much larger fund.
The firm is not the only one to focus on smaller deals.
Norwest Venture Partners, a subsidiary of San Francisco-based Wells Fargo & Co., launched a $300 million fund at the end of April. The size of the fund, the eighth by that name since the firm was founded, was in line with a strategy the firm has been following for years, said managing general partner Promod Haque.
Rather than raise a huge fund and then work off that sum, Norwest prefers to raise smaller pools of money more often. This allows the firm to spend more time on individual investments and, more important, include newly hired employees as participants in the funds - an important source of compensation for venture capitalists.
"What matters is not the size" but the speed at which the investments are made, Mr. Haque said.
Mr. Haque said Norwest will probably raise another fund in the fall; in the past, the lag time between the creation of new funds was more like three years.
These venture capitalists that have set their sights on raising more modest baskets of capital say investor appetite in the current market volatility has nothing to do with the funds' size.
But fund size "is a leading indicator of [future] investment," said Kirk Walden, national director of venture capital research for PriceWaterhouseCoopers, which publishes a quarterly venture capital survey.
For example, an uptick in fund raising at the end of 1997 and in early 1998 presaged a boom in venture capital investment levels in the first half of 1999, which were 70% higher than the year before.
Weisel and Norwest are already busy lining up investors for their new funds.
Part of Weisel's capital - $62.5 million - will come from a total of $1 billion the California Public Employees Retirement System has agreed to put towards new investment funds and business activities at the firm.
The rest of the investors will probably include many of the firm's strategic partners, which is a laundry list of major venture capital and private equity firms, such as the Mayfield Fund and J.H. Whitney. About 2% to 5% will be invested by employees as part of the merchant bank's compensation structure.
Norwest Venture Partners can be more flexible about its fundraising schedule because of its relationship with its limited partner Wells. The bank provides most of the money for the funds, eliminating some costs associated with negotiating with outside investors. It also doesn't have the pressure to raise a big pool of capital to draw against if investors turn off the tap.
"Wells has always supported us," even in a bad market, Mr. Haque says.
A Chase Manhattan Corp. unit is also planning to launch a fund, just directed at high net worth investors, within the next 60 to 90 days, said Charles Walker, a general partner at Chase Capital Partners and formerly managing director of private equity at Hambrecht & Quist.
Although the size of the fund could not be determined by press time, the fund marks a passing of management responsibilities at Hambrecht & Quist, the San Francisco investment bank bought by Chase last year. Hambrecht's private equity activities date back to its founding in 1968.
To be called Chase H&Q Capital Partners LP, the fund will be managed by Chase Capital, the bank's New York-based private equity unit. Chase Capital has already absorbed the $330 million Access Technology Partners LP launched by Hambrecht in 1999.
