As Atlas Splits, Is There A Case To Make In Venture For Specialists?

Xconomy National — 

Readers of this column who are of a certain age might remember Chrissie Hynde of the Pretenders in black eyeliner, dressed as a diner waitress singing, “I’m special, so special, and I gotta have some of your attention.”

Swap “money” for “attention,” and it could be a refrain that venture capitalists are singing these days to their wealthy backers. Cash is flowing into venture funds at a post-recession high, and with that brass in pocket, more VCs are investing with a narrower focus, say industry observers. How to quantify these specialists is a moving target, but the trend has been ongoing for a few years: old diversified firms have split into tightly focused ones, and new ones have launched from scratch.

Chrissie Hynde

Hynde: Special.

“Five or 10 years ago you had a lot of $500 million-plus funds that included a healthcare or biotech practice, but now there’s a real bifurcation,” says Theresa Sorrentino Hajer, managing director of venture capital research at Cambridge Associates, an advisory firm for institutional investors—pension funds, school endowments and other limited partners that put money into venture funds.

Some data also suggest it pays to be a specialist, sticking either to IT or healthcare, although that suggestion is more of a hint on the healthcare side, as we’ll see in a moment.

Atlas Venture of Cambridge, MA, is the most recent example of what Hajer calls a “bifurcation,” announcing this month its tech and life science teams would part ways and raise their own funds.

Another example is Lightstone Ventures, formed in 2012 by the healthcare investors from Morgenthaler Ventures and Advanced Technology Ventures. A generation ago, says Lightstone general partner Mike Carusi, VCs tended to be generalists. But now “the science has gotten harder,” he says, which means “the need for operating partners with specialized technical know-how—folks with PhDs after their name—becomes more and more important. These resources are only applicable to one side of the house or the other, healthcare or IT, and thus the skill sets of the teams continue to diverge.”

To be sure, the venture world is never static. Firms change direction, partners come and go. But every cycle has its own unique properties. The Great Recession dealt a blow to venture capital returns and began a shakeout that many felt was overdue. Some LPs gave up on venture entirely, but the momentum has shifted, according to the National Venture Capital Association and Thomson Reuters. With three months to go, U.S. venture fundraising in 2014 is up to $23.8 billion, the first time in five years it has surpassed $20 billion, and it could threaten the $31.1 billion mark reached in 2006.

Carusi: Specialist.

Carusi: Specialist.

So VCs have more money to invest. And more of those firms are specializing in tech or healthcare (or in even deeper specialties within those sectors). But are they doing better because of it? Here are two ways to slice it, using data from Cambridge Associates:

—For new investments made between 2001 and 2010 into IT companies, the gross internal rate of return made by diversified funds was only 8 percent. In contrast, the return for the specialist IT funds was 20.5 percent (or 2.7x gross multiple of invested capital vs. only 1.5x for the more general funds).

—For new investments made between 2001 and 2010 into healthcare companies, it’s more complicated. From 2001 to 2005, the diversified funds have a better track record than the specialists (11 percent vs 7.2 percent gross IRR; 1.6x vs. 1.3x multiple). As recently as 2012, Atlas Venture partner and blogger Bruce Booth used Cambridge data to underscore the better performance of diversified funds.

But since then, just like with Atlas itself, the story has changed a bit. Cambridge data now show that from 2006 to 2010, the healthcare specialists hold a slight advantage (13.1 percent vs. 11.3 percent gross IRR; 1.6x vs 1.5x multiple).
Perhaps that shift is simply a blip; it’s not wise to draw grand conclusions from such short time periods. But it’s also fair to note that the better performance by the healthcare specialists, boosted by two more years of return data, coincides with two years of unprecedented return activity in the healthcare sector.

Healthcare companies have accounted for 35 percent of the IPOs in the last 12 months. That’s more than double the contribution from the technology sector, according to the website

There’s an argument to be made that the 2012 JOBS Act might help keep the IPO window open—or at least less boom-and-bust volatile as in the past, which in turn could bring more stability to assuage risk takers. Could there, in turn, be more motivation for healthcare investors, whose ranks until a couple years ago were thinning, now to go their own way? That, of course, depends upon … Next Page »

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