Q&A With Bill Elkus of Clearstone Venture Partners

April 17, 2001
©2001 Private Equity Week

By Dan Primrack

Bill Elkus conceived the Clearstone Venture Partners (then known as Idealab Capital Partners) concept in 1997 and has been a managing member of its general partnership since its inception. He sits on the board of four firms, including GoTo.com, RealNames Corp., HealthAllies and Cooking.com.

Bill began his career at the Boston Group in 1977 with five years as a strategic planning consultant in a wide variety of industries, including semiconductors, magnetic recording media, and publication databases. In 1982, Bill founded Nathan Todd & Co., an investment advisory firm specializing in providing wealth management services and representing private family fortunes. During the period of his full-time involvement at Nathan Todd (1982-1993), he was active in several aspects of venture capital, including investments in traditional funds, co-investments with those funds, and direct venture investments. He also co-founded five independently managed investment partnerships in the areas of securities trading, real estate and merchant banking.

Last week, Idealab Capital Partners (ICP) changed its name to Clearstone Venture Partners and moved its operations out of idealab’s offices. Why are you trying to so strongly disassociate your firm from its former namesake?

The move that we made wasn’t to disassociate ourselves from idealab! the incubator, but rather to make it clear in the minds of the media and entrepreneurs and other venture capitalists that we’re separate entities. We’ve had a lot of issues of brand confusion for the three years we’ve been in business. People sometimes think that we are a creator of companies, and people sometimes think idealab the incubator is a VC. We’ve had investments attributed to us in the press as recently as [Tuesday] that we’ve never made. The best way to make it clear to people that we have a different portfolio and different investors was to simply take a different name. As far as the offices are concerned, that was just a personal preference. The idealab! office in Pasadena is over 30 miles from my house and the houses of each of my full-time partners. We’re also space constrained inside of the incubator, and I know they’d love to have the extra space for themselves, so it all just worked itself out.

When you went out to raise your first fund in 1998, the idealab brand name was obviously a strong incentive for investors to take a look at you. When you went out late last year to launch Fund III, was the idealab! moniker viewed as a drawback due to its recent layoffs and pulled IPO?

Our investors are overwhelmingly sophisticated investors, such as CalPERS, The State of Michigan, Goldman Sachs and Merrill Lynch. These people have dozens and dozens of venture funds, have done extensive due diligence on us and are not at all confused between idealab! and Clearstone. Whatever is going on at idealab itself as a brand I don’t think has a positive or negative impact on our ability to raise a third fund.

On a separate issue, idealab! has provided dealflow for us but, over time, the dealflow that they provided for us became a smaller and smaller part of the total dealflow available. It was a tremendous advantage for us in the beginning, but since then we’ve added partners, gained what I think is a good reputation and have more experience in the marketplace. All of these have greatly added to our non-indealab! dealflow, which is now much larger than our idealab! dealflow.

You ended up pulling that fund off the market after approximately four months of fund-raising. Why?

When we go out into the marketplace we, like most venture capitalists, look at our existing portfolio companies and estimate how many of them will present attractive [follow-on] investment opportunities. And that changes every month: Sometimes it goes up, sometimes it goes down.

The second thing we look at is the rate in which we’re investing in new deals, and the third thing is how much we invest in each new deal. So that gives you a sense of your cash forecast and when you need to raise your new fund. When we first went out to market we were in a different market environment than we are right now and our forecasts were that around now we should have a new fund under management.

In all three of those cases we’ve seen fairly significant changes. Our existing portfolio companies are, to use someone else’s words, hoarding cash. They are retrofitting their business models to use the cash they have as frugally as possible. They’re seeing a financial environment where the private equity markets are not very friendly, where the public markets don’t exist as a practical matter and, more importantly, where their competition isn’t growing as quickly and, in some cases, is dead. So many of our existing companies have said they don’t need to raise money right now under these circumstances.

On the new deal side, I think everyone is finding that their investment pace has slowed. Part of it is because fewer companies meet our criteria and part is because we can now conduct longer due diligence… we aren’t losing deals because we’re taking a long time.

When we do make an investment, companies don’t need as much money in the early stage – and we’re early-stage investors -- as they did a year ago. The 1997 to 1999 imperative to get big fast before even proving your business model has been lost. So we looked at out portfolio and said we have a lot of runway left in Fund II, and we should not be closing Fund III yet because it’s not appropriate.

So we went back to our investors in the last few weeks and asked if they wouldn’t mind postponing the closing of the fund. We had never given them documents or asked for a final answer. Most of them were still involved in their own due diligence, and it’s been reported that a couple of major institutional investors planned to invest more than they did last time. We were going to have a dry closing anyway and thought, let’s just wait. We think we can go well into 2002 with what we have now and probably do eight to 12 more new deals in our existing fund.

Since the conventional VC wisdom is to raise capital before you actually need that capital, when would you expect to go out and raise Fund III?

Sometime in 2002. We basically look once a month [and project our cash investment pace] and will raise it when we feel the circumstances are appropriate.

Idealab! CEO Bill Gross was a co-founder in ICP, but is not listed in the management section on the new Clearstone VP Web site. Is he still an active member of the team?

Bill’s role hasn’t changed. What we didn’t want was an entrepreneur who thought he might be getting Bill Gross’s time -- which is very attractive to a lot of entrepreneurs -- by having him up on the Web site as one of the active managers. Bill is a full-time executive who’s got a lot on his plate and has always given us part-time help and part-time advice inside of ICP by design. Not including him on the Web site was also another way to further separate the brands.

Idealab! itself was also involved in ICP by design in that it had a significant financial stake in the two existing funds. Is idealab going to maintain those positions?

Yes. We don’t discuss, and have never publicly discussed, their ownership in our firm so I won’t give you any details, but idealab! has a very strong incentive for both of our funds to be successful.

When you went out and started marketing Fund III, was idealab! going to maintain its traditional role within the new fund?

We didn’t disclose that to our investors. Like most venture funds, the internal economics amongst the partners is not disclosed in the offering memorandum.

Why did you pick the name Clearstone Venture Partners?

Picking a name was very difficult. We wanted a name – sorry for the pun – that was clear, easy to spell, was memorable and that evoked a sense of what we were trying to accomplish. So we looked at a lot of names and came up with this one. The other thing you can do is name it after people, but Elkus, [Managing Director Erik] Lassila and [Managing Director William] Quigley are three very difficult names to spell. [Managing director Jim] Armstrong is a lot easier, but with three out of four being difficult we decided we’d go with a more generic name.

Is there any difference in investment missions between ICP and Clearstone?

No. The difference might be apparent in the public mind only because the public hasn’t always focused on the fact that the ICP portfolio is much more than eToys, NetZero, GoTo.com and MP3.com. Those are some of the companies that got a lot of attention in 1998 and 1999 and were big wins for us, but we’ve always had a significant technology portfolio. Over the last year and a half, we’ve spent much more of our investment dollars on [technology-centric] companies, and that hasn’t been really talked about much in the press. Companies that provide deeper technology are a little more difficult to describe and are not as transparent to the average newspaper reader. We recently announced an investment in Zyoptics, which is an optical equipment manufacturer, and it just doesn’t sound like as much fun as an eToys, so people don’t focus on it that much.

Our firm has been focusing for some time on software and communications. We are a group of venture professionals who have significant experience doing these kinds of transactions. Our experience and success in b-to-c and Internet-related companies is significant, and we’re proud of it, but it does not represent the bulk of our careers. For example, William Quigley was at Mid-Atlantic Venture Partners before he joined us and did eight communications deals there. Erik Lassila has been in business as a VC for six years. Before that he was at Motorola and Texas Instruments so he has a lot of experience with enterprise software.

On a broader level, should the VC community be concerned that the recent spate of established firms pulling launched funds will cause institutional investors to decrease their future allocations to the industry?

No, I think it’s very much the other way around. The institutions make allocations to the space and then go find the best firms that they can. I don’t think they’ll say, ‘If we can’t find enough good firms to invest in we just won’t invest.’

There was a movement late last year to raise very large funds, and it resulted in many institutions being overallocated to VC because they wanted to keep their place in good funds. Also, a lot of the institutions we’ve talked to don’t have a full view of the losses they’ve taken in their portfolio due to the nature of venture reporting. It tends to be very sticky on both the upside and the downside, and I think it will be many months before they understand exactly what shape their portfolios are in. They may have less invested in venture than they think.

Anything else you’d like to add?

This is an exciting time for us because we are growing as a firm. We expect to make additional announcements on personnel over the next few months as we’ll be making additions at all levels. We’re establishing two new offices and have $200 million to invest, and it’s a great time to have cash to invest, so we’re looking forward to making some great deals and building some really good companies.

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