Kleiner & Sequoia’s Fund Returns Could be Exposed in CA Lawsuit

3/27/13Follow @curtwoodward

As venture capital firms feel the squeeze from new competitors, unsatisfied investors, and stagnant markets, two of the industry’s biggest names could finally have their performance data revealed to the public.

A California lawsuit from the news organization Reuters is threatening to expose the performance records of Sequoia Capital and Kleiner Perkins Caufield & Byers—Silicon Valley firms that are among the most well-known in the secretive world of VC investing.

If it’s released, the information would provide a fuller picture of how VCs have done over the years and show whether some of the bigger name brands in the sector have done better or worse than their less well-known competitors.

The lawsuit also comes at a critical time for many in the VC industry. Traditionally governed by discretion and close relationships, American venture investing has seen new competition in recent years from boisterous former entrepreneurs like Andreesen Horowitz and new foreign players like Yuri Milner’s Digital Sky Technologies.

The foundations and public employee pension funds that bankroll VC have also become more activist and critical, in some cases pulling back on their investments or complaining that VC performance has stalled in the past decade while some firms sought ever-bigger funds that paid generous fees simply for showing up to work.

That transformation has happened just as the cost to start a digital company has plummeted, making it possible for entrepreneurs to create businesses without tens of millions of dollars in venture capital backing. At the same time, adoption of mobile devices and ever-faster data networks have exploded, sparking a growing hunger for the kinds of innovative digital services from startups that VCs typically like to invest in.

Amid all of that change, the number of venture funds has been shrinking, with power consolidating in the hands of the biggest names and top performers. In short, it can be a rocky time to be a VC—especially if people start asking how your investment decisions have panned out.

For its part, Reuters is seeking pretty basic stuff: the amount of cash invested and returned from 10 specific Sequoia and Kleiner Perkins venture funds over a span of several years, along with their net value and internal rates of return.

Many other VC and private equity firms already have that information disclosed by the public investment funds that supply them with cash. The California Public Employees’ Retirement System (CalPERS) and the California State Teachers’ Retirement System (CalSTRS) are two of the best-known public asset managers that publicly disclose the returns they get from their venture capital portfolios, in addition to their performance in the usual mix of stocks, bonds, and real estate funds.

But Kleiner Perkins and Sequoia have avoided that scrutiny through a sort of shell game with the California university system, which invests about 2 percent of its more than $70 billion fund in such “alternative investments.”

Instead of supplying the university system with information on individual fund returns, Sequoia and Kleiner Perkins report “blended” data showing the overall amount of money invested in and returned from the larger firm.

In turn, the university system is given access to more detailed financial information on specific portfolio companies in the various Kleiner Perkins and Sequoia funds—but that information can’t be released to the public under California law.

The upshot is that you can log on to the California state employees or teachers pension system websites and get a broad sense of how many private equity or venture capital firms have done over the years, including competitors of Kleiner Perkins and Sequoia.

But information on those two top-tier firms is nowhere to be found.

Reuters has already won a lower-court ruling, which held that the universities should try to get the individual fund data from Sequoia and Kleiner Perkins so it could be exposed. The two firms have been notably silent on the case, but the California university system is fighting the ruling.

In a press release announcing its appeal, the universities criticized Reuters for seeking the return information, saying the news organization simply wants to profit from the traditionally confidential information by producing investment products that it can sell to subscribers.

If the lower court ruling is allowed to stand, “no one who does business with the government can be assured that otherwise confidential documents—unused and unseen by the government—will not be released to competitors or opportunists,” university system attorney Charles F. Robinson said.

They seem to have a compelling legal argument. But you have to wonder: Just what sort of horrible fate would really befall Sequoia and Kleiner Perkins if they were forced to pony up information on how their old funds did? (The two firms cut the university system’s pension fund out of most new investments after 2003 because of the threat of public exposure of their performance data).

First of all, it’s not a secret how venture capital as an overall group has done over the years. At the risk of oversimplifying things, the short version is that there were some amazing years in the 1990s, peaking around the time of the dot-com bust. But the decade or so since then has been relatively lackluster.

That’s actually reflected in the court case. In a footnote, the lower court judge says the universities saw unspecified “spectacular returns” with some Sequoia and Kleiner Perkins funds, including investments in 1992, 1994, 1996, and 1998. But the university system also has lost money on Sequoia and Kleiner Perkins investments from 1999 and 2000 (although the court filings don’t say which particular funds accounted for those losses).

Moreover, Kleiner Perkins has itself acknowledged some uninspiring performance in the past few years. According to this Reuters report from early this month, which quoted several unnamed investors who attended a private meeting, the lionized Silicon Valley firm recently apologized for subpar returns and promised to improve.

There’s also no evidence that the other firms that have subjected themselves to public disclosure of their returns have been badly compromised just because of that scrutiny—scrutiny that comes, don’t forget, in exchange for big checks from the retirement nest eggs of public employees like teachers, cops, and firefighters.

In the end, the arguments for secrecy seem to come down to the sentiment expressed in a Sequoia letter to the university system in 2003, after the firm decided to boot its longtime investor from future funds because of the threat of public disclosure:

“Discretion and privacy are the handmaidens of successful venture capital firms,” it read. “The venture capital industry is damaged when alluring performance information attracts billions of dollars of hot money seeking quick returns.”

In other words, the big VCs didn’t like the idea that data about their successes would get out and alert other capitalists to the nice little cottage industry that had been built up in the Valley.

But that’s happened anyway. These days, the push to keep publicly funded VC data from the general public seems more likely to be motivated by the unwillingness to show just how these top-tier funds have performed, just like the dozens of other firms that take public cash.

Curt Woodward is a senior editor for Xconomy based in Boston. Email: cwoodward@xconomy.com Follow @curtwoodward

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