Venture Capital Brings Harvard Riches

New technology businesses are popping up by the second, urged into existence by the hundreds of venture capital firms, the lifeblood of start-ups. In its own small way, Harvard is contributing to this boom, through the investment of its $14.4 billion endowment.

Over the last decade, Harvard has put billions of dollars in venture capital. While money managers for the Harvard Management Company (HMC), the company that invests the endowment, refuses to reveal the exact amount in venture capital, they say their goal is to have 15 percent of the endowment in private equity, the category that is in large part defined by venture capital.

Harvard picks its venture capital firms it uses--third party companies that pool several investors' funds--but then trusts these firms to do its investing. So, Harvard does not actually choose the companies it believes will be the next Microsofts and Intels of the business world.

Last year investors in venture capital, including Harvard, were handsomely rewarded for their venture capital investments. While Harvard's overall endowment growth slowed, the venture capital portion had a return rate of 136 percent.

"Harvard would own most of the countries in the world if these returns continued for 10 years," says Bob Higgins '68, founder and managing general partner of venture capital firm Highland Capital Partners, one that HMC invests in.

According to HMC President Jack R. Meyer, the company does not expect these kinds of returns from venture capital in the future.

"As we look at venture capital going forward, we don't expect triple digit returns," says Meyer. He says HMC expects in the long term, venture capital will return 10 percent above the rate of inflation.

Meyer says that HMC chooses firms that historically have had high rates of return on their investments.

"Success begets success in venture capital," says Meyer.

HMC invests in a broad group of third-party venture capital firms. These firms are located across the country, from Highland Capital Partners headquartered in Boston, to Crosspoint Venture Partners, of northern California, to Walden International Investment Group of San Francisco. These companies invest in firms focusing on a broad range of start-up companies, from the internet to communications to health care.

Familiar territory

Venture capital is certainly not a novel concept for HMC. According to Meyer, Harvard first put money into venture capital in 1978, the year Intel introduced the 8086 microprocessor. HMC has set the 15 percent goal for private equity in1992.

HMC investors could increase this goal to 20 percent without consulting HMC's management board, a group of top University administrators and outside investment specialists. But raising the number beyond 20 percent would require a conversation with the board.

While Harvard used to invest directly in businesses without the help of the third-party companies, changes in the tax laws after the Republicans took control of the Congress made this difficult to continue.

"Ten years ago, [venture capital investment] was nothing like today," says Meyer.

He notes that in the 1980s and early 1990s, it usually took seven to 10 years before the profits were returned to the endowment. Now, HMC can get large profits back from its investments in two to three years.

Meyer adds that there was less interest in venture capital investing 10 years ago.

Don't miss the boat

Universities across the country are biting at the bit to get their stake in venture capital.

The percentage of university endowment money invested in nonmarketable securities, largely venture capital, increased from 3.6 percent in 1990 to 7.2 percent in 1999, according to the National Association of College and University Business Officers. Among private universities, the investment is even higher.

Higgins says universities are the ideal investors for venture capital. Since only the interest on the endowments is spent, he says, investors do not panic during temporary downturns and understand the importance of long-term investing. Over half of Highland's institutional investors are university endowments.

The success of venture capital has given some schools handsome rewards. Williams College saw a 29 percent rate of return from its endowment for the year ending June 30, 1999, thanks to shifting from traditional stock investments to venture capital and similar nonmarketable investments.

This rate of return on the endowment played a large part in Williams' decision not to increase its tuition levels for the coming year, an unprecedented occurrence for a private selective college.

According to Williams College Treasurer Doug W. Phillips, the school's goal is a 25 percent investment in private equity, one half of which is venture capital.

Despite the rush of money chasing the incredible returns, possibly building up a speculative bubble, Meyer says that venture capital investment should not be labeled as a fad. He notes that venture capital is at the heart of the capitalist economy, in some ways more than stock market investing.

And this increased interest in investing in venture capital is not all good news for Harvard. Last year the University was not able to invest as much money as it would have liked in venture capital. Venture capital firms are not able to accommodate the heavy requests to invest and are force to set caps on the amount of money universities can invest. Because Harvard's endowment is so large the smaller amounts have less effect on the bottom line.

"Ten years ago Harvard had little trouble putting as much money in [venture capital] as we'd like," Meyer says. "Today we'll say $70 million and they will take $25 million."

Meyer says that since July 1, HMC has been able to bring its venture capital investments close to its 15 percent goal. He also notes that one reason Harvard had problems being fully invested in venture capital was that it tries to only invest in the top-tier firms with proven track records, not wanting to face undue risk.

Risky Business?

The possibility of triple digit returns does not come without some substantial risk, however, Meyer says.

"Venture capital firms loose all of their money on 80 percent of investments," Meyer says. "However, if the home runs are big enough, they can do fine."

Meyer and Phillips say the third-party investors can make a big difference in how much the schools gain from venture capital.

"The key is that risk can be mitigated by having good people manage [venture capital firms]," Williams' Phillips says. He notes that venture capital managers' income and wealth heavily depends on the success of their funds, which limits the unnecessary risk these investors are willing to take.

Even with the high risk of venture capital investments, Meyer says it is an important and necessary part of Harvard's and other universities' endowment investments. He notes that while the investment itself may be risky, the diversity of the endowment portfolio, enhanced by venture capital, mitigates the danger of great losses.

"The risk in the [endowment] portfolio is lower today than it was eight to 10 years ago," Meyer says.

Moody's Investors Service, a company that measures the financial strength of universities to determine their bond credit ratings, expresses a similar view about endowment risk.

"We believe that the diversification of the larger endowment portfolios will help reduce volatility of investments over the longer term," a report released in Feb. 1999 says. "If the U.S. equity markets enter a significant period of poor performance, university investment officers expect these non-traditional asset classes to reduce the volatility of their investment returns over the long term."

Despite its attempts to avoid as much risk as possible in venture capital investing, Meyer says HMC understands it could lose significant amounts of money in these investments and is prepared to take these loses. These kind of loses would not be unprecedented, as the endowment lost $1.3 billion in the summer of 1998 in emerging-market and other risky investments.

While Meyer has not enjoyed the market volatility of the past few weeks, he says it is not a major concern to him. He has not, he says, lost any sleep over the sharp market declines.