In The News Students Get Chance To Invest Like the Pros
By CHRISTOPHER ZINSLI
The Wall Street Journal - September 17, 2008
Roy Ashok's plans for this semester at Cornell University include organizing field trips as president of the school's technology club, deciding which job offer to accept upon graduation next year -- and breaking news to his venture-capital firm's shareholders that one of their investments has gone belly up.
Mr. Ashok's plight is a rare one. While many venture firms use MBA students like him to carry out due diligence and other chores, a handful of business schools are experimenting with giving students free rein over how to invest millions of dollars. These programs function much like real-world venture firms, but they face unique obstacles and remain unproven ventures.
Student venture capitalists do nearly everything their professional counterparts do -- sourcing and selecting deals, negotiating terms, counseling portfolio companies -- with minimal interference from college administrators and advisers. Investment decisions, researched and recommended by committees of students based on their areas of study, are voted on by the full groups, which can consist of up to 30 students.
"This is just a real-world experience," said Mr. Ashok, 30 years old, of Cornell's Big Red Ventures. "You can't get better than this."
That judgment is up for debate. There are no financial rewards, such as carried interest or management fees, for the students, nor are there any incentives for the limited partners. The students invest money from endowments by wealthy individuals, and any profits are returned to the funds for reinvestment.
Companies taking funding from student venture firms are often, though not exclusively, launched from the schools' innovation programs and the surrounding areas. In other cases, real-world venture firms with ties to the universities carve out a portion of certain deals for the students.
Such was the case with life-sciences investor Arboretum Ventures, which brought on the University of Michigan's student-operated Wolverine Venture Fund for its initial investment in medical-device coatings company Accord Biomaterials Inc.
"A little bit more money never hurts," said Tim Petersen, managing director of Arboretum. "They're not demanding governance roles, they're not demanding board seats. What they're asking for is some access for a learning process. It's kind of like, 'Why not?' "
Not the Parents' Money
Because the ownership stakes the student firms take are tiny -- often just a fraction of a percent after several rounds of dilution -- they face a constant struggle to maintain a say in how their portfolio companies grow.
"We don't have much control over exits or the running of the business," Mr. Ashok said. "If you're a small investor...you're basically playing second fiddle."
To combat this, Big Red is planning this year to shift its focus to slightly later-stage investing, to Series A rounds from seed. The firm plans to hit the road this month to solicit Cornell alumni for commitments to a new fund with a target of "much more" than $10 million, Mr. Ashok said. Big Red currently has $1.5 million under active management from the endowment that launched the firm in 2001.
Similar concerns drove another student-managed venture firm, Dakota Venture Group, onto the fund-raising trail. The firm, launched in 2006 with a $300,000 endowment and run by MBA students at the University of North Dakota, seeks to raise a $5 million "harvest fund" -- one whose investors reap the profits -- to take larger stakes in more-advanced companies.
Nathan Carpenter, 22, one of Dakota Venture Group's five current managing directors, said the firm already has received commitments from individual investors for $100,000 toward the harvest fund, and he would like to have the full amount secured by next fall.
But Mr. Carpenter and fellow Managing Director Jordan Schuetzle, 25, know they have a tough case to make.
"It will be hard to raise the money, there's no doubt about that," Mr. Schuetzle said. "Not a lot of people are going to be willing to invest in a bunch of students with no oversight."
It is common for student investors to face skepticism about their business acumen. But several real-world venture capitalists that have co-invested with them said the students often prove their worth in the due diligence phase. In at least one case, students discovered wrongdoing in connection with a company they were vetting.
Anthony Warren, faculty adviser for the Garber Venture Capital Fund, said that a few years ago, students managing the $5.5 million vehicle from Penn State University uncovered a case of securities fraud. The company had split part of its technology into a separate legal entity, and when students dug into the second entity, Dr. Warren said, they found that a placement agent had raised $5 million on false claims. The students' discovery led to legal action against the agent, he said.
When School's Out
The most cited downside to letting students run a venture-capital firm is the difficulty of operating on an even keel against waves of student managers lost to graduation.
That dilemma is now playing out at Big Red Ventures. Mr. Ashok and his peers had nothing to do with their firm's $50,000 investment in now-defunct Experience Enterprises LLC. That decision was made in early 2006, yet it falls to this generation of managers to explain the company's recent dissolution to Big Red's investors.
"You've got to live with the mistakes of the previous batch" of students, Mr. Ashok said. "I can't hold the managers who invested in Experience Enterprises accountable for their actions."
To cope with the hurdles raised by a revolving team of fund managers, most of the student-guided firms make involvement a two-year commitment, giving underclassmen a year to learn the ropes before they take on a greater role as managers. The new recruits are often put through intensive training to bring them up to date on the funds' portfolios. Advisers with experience as professional investors add continuity, as do alumni networks giving current managers access to former ones.
Although many of the student investors aim for careers as venture capitalists, it is more common for them to score jobs at venture-backed companies after graduating.
"The venture capitalists really like someone in [a] company who understands all the gobbledygook" about term sheets and valuations, said Dr. Warren of the Garber Venture Capital Fund.
That strategy worked for Cornell alum James Macon. He was part of the team at Big Red Ventures that recommended participating in a small seed debt round last fall for e2e Materials LLC, a maker of biodegradable composites based on technology from Cornell's Center for Materials Research. Now he is vice president of business development for e2e and leading its search for a Series A financing round of about $7.5 million.
Making The Grade
Most student-run venture firms are still too young to say how successful they have been as investors. So far, their victories are about as numerous as their setbacks.
Wolverine Venture Fund, a $3.5 million fund that has been investing for more than a decade, has seen two of its portfolio companies close, and two others turn a profit. Its biggest success was laser-eye-surgery company IntraLase Corp., a University of Michigan spinout that went public in 2004, returning Wolverine about five times its investment of less than $250,000, according to Thomas Kinnear, faculty adviser for the fund.
The Garber Fund is likewise batting even, as its first two investments, both from 2002, have been seen to their conclusion. High-school portal Schoolwires Inc. recently gave the fund a 50% return in a private transaction, and e-procurement company Alphasource Procurement Systems LP ceased operations late last year. Dr. Warren said the real-world venture firms with which he is involved "are probably doing worse at the moment."
The newest of the student-directed firms, Dakota Venture Group and Frankel Commercialization Fund, are awaiting their first exits and dreading their first failures.
Click here to learn more about the Dakota Venture Group