May 11, 2004
Shhh! Venture Fund Results
Posted by Gordon Smith

The returns earned by venture capital funds are private, and the venture capitalists want to keep it that way. For several years, a battle has been underway over the confidentiality of venture fund results. When the internet bubble burst, stakeholders in public pension funds began to agitate for disclosure. The WSJ ($)provides a concise history of the battle, focusing on the debate in California.

Here is the quick history of litigation over the University of California's venture investments:

Venture capitalists said data on their interim returns were a "trade secret." They also were worried that if information on the overall performance of their funds was made public, details on the performance of individual start-up companies in the funds might eventually leak out, too.

In July, Judge James Richman ordered UC to release its records. "... [T]he public interest in disclosure [of return data] clearly outweighs the claimed need to keep them secret," the judge wrote. UC asked Judge Richman to reconsider. It pointed out that just before his ruling Sequoia Capital had responded to the University of Michigan's disclosure of data by booting UM out of a new Sequoia fund.

Then, shortly before the judge offered his reconsidered ruling, Sequoia sent the letter severing relations with UC. "It is not in the interests of Sequoia Capital's other clients that we be hounded, badgered, and stalked by entities wishing to either profit from or publicize our private and confidential information," wrote Mr. Moritz, the Sequoia partner. He called it "the saddest business letter ever dispatched on Sequoia Capital stationery." Through a spokesman, [Michael Moritz, a Sequoia Capital partner] declined to comment.

In his second decision, Judge Richman again ruled against UC. Two appeals to a state appellate court and the state supreme court failed. In mid-October, UC released records of its venture holdings.

The ripple effects of this sort of action are predictable. For existing investments, venture funds are reducing the amount of information that they send to public investors. For future investments, public institutions may simply be excluded (as has already happened in numerous instances, including the University of Michigan case referred to above). Importantly, the venture funds most likely to refuse public money are those sponsored by the most successful venture capitalists, like Sequoia.

Critics argue that venture capitalists are attempting to avoid the embarrassment that follows disclosure of poor performance. This is silly. Consistently poor performance carries its own punishment (the refusal of existing investors to contribute to another fund). The more plausible explanation for the VC reticence is the one most VCs use: ongoing disclosure of results is misleading because most portfolios follow a pattern of early losses followed by gains. Why? Because bad companies fail faster than good companies succeed. Negative results will subject the venture capitalists and the investment managers at public institutions to public pressure and second-guessing.

Given that most public institutions invest only a small portion of their funds in venture capital, the drive to disclose venture capital results seems motivated more by politics than principle. This seems like a pyrrhic victory for the public.

UPDATE: Steve Bainbridge blogs this same story with a flair: "As a result of a suit by Woodward & Bernstein wannabes in the press, wet-behind-the-ears students who probably can't even spell investment let alone read a financial statement, and grumpy old fart pensioners, however, the university has been required to disclose a host of financial data on its VC fund investments." Can you guess which side he's on?

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