Friday, August 12, 2005


Daniel over at PE Week Wire has been writing about VCs more often than usual over the past couple weeks. He usual has some story on private equity firms. Anyway, he has the scoop on how seven top-tier limited partners did not come back and invest in Mayfield's new fund. Entertaining read if you're interested in this space:

Mayfield, one of the earliest and most prestigious venture capital firms, has lost its luster among the crème de la crème of limited partners. The Sand Hill Road firm is about to close its twelfth fund, but without at least seven top-tier limited partners who had invested in prior Mayfield funds. What follows has been independently confirmed with five different sources, who agreed to speak only under the condition that neither they nor their institutions be identified. What I can share, however, is that the seven dissenting LPs are brand names – in some cases household names – from the university endowment, private foundation and fund-of-funds arenas. Also, I made multiple attemps to speak with Mayfield (and offered to hold the story until the fund closed, if Mayfield was concerned about SEC regs), but never received a response.

The roots of Mayfield’s problem lie in its eighth and ninth funds, which were closed in 1995 and 1997, respectively. Each fund featured budget-based management fees, which is an alternative to the status quo of charging LPs an annual percentage (typically 2%) of total committed capital. Budget-based fees require the firm to annually come up with an itemized expense list, and are generally considered LP-friendly measures that also are employed by firms like Greylock and New Enterprise Associates. In Mayfield’s case, the partnership agreement allowed the firm’s annual budgets to equal up to 2.5% of committed capital, but it never came close to doing so. Therefore, LPs were initially happy, particularly because both funds also happened to be wildly profitable.

One problem for firms with profitable funds, however, is that they sometimes can generate “clawback” situations (for those unfamiliar with clawbacks, I’ve posted an explanation). This happened with both Mayfield VIII and Mayfield IX, which theoretically meant that the Mayfield general partners would have to reach into their own pockets to compensate their LPs. Standard operating procedure.

What Mayfield did next, however, was stunning. Rather than taking out its collective checkbook, sources say the firm proposed a partnership amendment whereby much of the clawback would be paid by charging LPs the difference between what they had paid in management fees, and the 2.5% maximum that they could have been charged. Analogy? You buy a loaf of bread on sale at Wal-Mart for $1.50 instead of for $2.00. When you go back to the store the following week, the Wal-Mart greeter asks you for the fifty cents. Even worse, Mayfield was asking for a cumulative payment, based on the "savings" that LPs enjoyed over the life of the funds.

Most LPs, of course, balked at the proposal. It wasn’t the first time that a VC firm had proposed a fee-for-clawback exchange, but LPs tell me that Mayfield was the only one to do so without its metaphorical hat in hand: “It was like they never even considered that we might disagree,” says a fund manager whose institution chose not to re-up for Mayfield XII. “The whole thing could probably have been avoided if they had just shown a little humility and interest in working with us on something that we could all live with.”

But Mayfield refused to give up, and the discussions moved quickly through another couple of stages before Mayfield basically offered an ultimatum to the dissenters: Vote to ratify the amendment or we’ll just pay the clawback out of cash on hand (read: committed LP cash on hand, plus future management fees). Two LPs tell me that they consulted attorneys on the matter, but were told that the case was gray enough that either side could prevail in a courtroom. The result was that enough – albeit not all -- LPs bit the bullet and signed the amendment this past spring.

"They are arrogant in dealing with LPs, and I’m saying that in the context of most VCs being arrogant," says a Mayfield investor. That characterization was used by all but one person I spoke with.
(full post)

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