Brentwood: Region’s Star in Venture Capital

No region of the country is more closely associated with venture capital activity than Northern California.

Apple Computer, Genentech, the entire Silicon Valley--all have been nurtured by venture capitalists, the celebrated investors who take big risks by backing start-up companies in hopes of reaping even bigger rewards.

The Bay Area is home to 16 of the nation’s 100 most active venture capital firms, according to Venture magazine’s most recent survey, compared to just four in Southern California.

So it may come as a surprise that the seventh most active venture firm in the survey was Brentwood Associates, the largest and most prominent independent venture capital firm in the Southland.

Despite the relative dearth of venture capital activity in the Southland, Los Angeles-based Brentwood has quietly won a reputation as one of the savviest incubators of new businesses anywhere since its founding by three partners in 1972.

“They are among the real pros in the industry,” says venture capital guru Stanley Pratt, publisher of Venture Economics. “They stack up well against any firm in the country.”

With high-tech entrepreneurs multiplying in Orange and northern San Diego counties and the San Fernando Valley, Brentwood appears to be well-situated to take advantage of the “explosion of venture capital activity in Southern California” that Pratt is predicting.

Brentwood, which makes more than half of its venture capital investments in Southern California, has indeed built an enviable record--although a direct statistical comparison with competing firms is impossible because of the varying life spans of venture capital funds and different ways of calculating returns on investment.

Over the years, the firm’s limited partners--typically insurance companies, pension funds and other institutional investors--have poured $275 million into five funds run by Brentwood. The funds’ return on investment has ranged from 18% a year to an eye-popping 46%. The firm notes, however, that the 46% return was an interim result that came during the hot new-issues market of 1983 and has not been sustained.

“It varies year by year,” said Tim Pennington, one of the firm’s three founding partners. Returns can be dramatically affected by the stock market’s receptiveness to initial stock offerings, he said.

Small investors need not apply. The minimum ante for limited partners is $2 million, and the money is tied up for as long 13 years.

“Brentwood’s people have gone through several cycles with their track record intact,” says A. Kipp Koester, manager of investments for Northwestern Mutual Life Insurance Co., a Milwaukee firm whose $5 million in a Brentwood fund is one of about a dozen venture capital investments Northwestern has made. “They’re one of the premier groups in the country.”

The object of this praise is a tightly knit team of eight partners and two associates, all MBAs. Until recently, they all worked out of the same suite in a San Vicente Boulevard high rise.

But earlier this year, Brentwood opened its first office outside of Los Angeles at 3000 Sand Hill Road, the Menlo Park, Calif., address that houses some of Silicon Valley’s most celebrated venture firms.

That office is staffed by newly named partner Ed Zschau, the entrepreneur-turned-politician who ran unsuccessfully against Sen. Alan Cranston (D-Calif.) last year as a Republican and whose company, System Industries, was once financed by Brentwood.

Zschau says it is “refreshing” to be back in the business world. “You can make things happen much more quickly than in Congress,” he says, adding quickly that he still plans to seek a Senate seat again.

Later this year, Brentwood will open its third office in Costa Mesa to be close to Orange County’s burgeoning medical devices and medical technology industries.

Besides seeking geographic diversity, Brentwood in recent years has been adding a new type of investment, leveraged buyouts, to its portfolio of venture capital investments.

Such debt-financed purchases of established companies can offer the same dramatic appreciation potential as venture capital investments--often with less risk.

Brentwood’s $1.1-million leveraged buyout in 1984 of Ideal School Supply Corp., an Illinois publisher of educational materials, soared in value to $33.9 million when the company went public two years later. (Last year, in another leveraged buyout, Brentwood purchased three graphics arts subsidiaries from Times Mirror, a diversified media company that publishes The Los Angeles Times.)

Would Have Started Elsewhere

“Looking forward, I feel we are very well-positioned geographically,” says B. Kipling Hagopian, one of the firm’s founding partners.

But in retrospect, Hagopian says: “If I could turn the clock back to 1972, I would have started the firm in Silicon Valley.”

That was before the microprocessor and the personal computer had given Silicon Valley its present mystique. Co-founders “Fred Warren, Tim Pennington and I were living in Los Angeles, and it didn’t even occur to us to go elsewhere,” Hagopian recalls.

The Southland has never matched the Bay Area as an incubator of new technology for a number of reasons, venture capitalists say.

Historians often point to Stanford University and its superb scientific resources in tracing the evolution of Silicon Valley.

Stanford was the lure that brought the “father of the transistor,” William Shockley, to Palo Alto when he left Bell Laboratories in New Jersey to set up a semiconductor company in 1956.

With the Nobel Prize winner’s Shockley Semiconductor Laboratories serving as a catalyst, the valley became the spawning ground for high-tech start-ups. First came Fairchild, then Intel, Advanced Micro Devices, National Semiconductor and hundreds of others.

Semiconductor makers produced raw materials for new industries, including those making personal computers and their peripheral equipment--printers, disk drives, communications gear and more.

Of course, Southern California has always had its share of technology, but much of it is concentrated in a handful of large defense contractors.

“The aerospace industry is not as conducive to spinoffs,” Hagopian says. “It has a mind set that is geared to large, cost-plus contracts, and sales to a single customer, the government.”

Awareness of Rewards

Another factor that has worked against the development of a high-tech entrepreneurial culture in the Southland is its vast size. “It is a sprawling region, much more geographically dispersed than Silicon Valley,” says Brentwood partner G. Bradford Jones.

“Among the managers who are likely to start an entrepreneurial company, there has to be an awareness of the rewards, of the availability of capital and of the procedures for putting together a business plan and a company” Jones adds.

For an ambitious manager or engineer in Silicon Valley, starting a high-tech business became the thing to do beginning in the late 1970s. Porsches, Ferraris and Rolls-Royces--often synonymous with Hollywood in Southern California--were viewed as the rewards of high-tech entrepreneurship in the North.

To be sure, Brentwood has been no stranger to the action in Silicon Valley. Over the years, it has placed between 30% and 40% of its venture capital in Northern California and has had its share of winners. A $1.1-million investment in Apple Computer in 1979 is worth about $70 million today.

Still, in the venture capital business, there is no substitute for proximity. “Any venture capital fund tends to do more business in its own backyard,” says Pratt of Venture Economics.

“You hear about the best deals from local sources,” he continues. “And most people want to be able to drive over to make sure a plant is still in operation before they send more money to meet the payroll.”

Close Working Relationship

As Pratt suggests, there is an extremely close working relationship between venture capitalists and the businesses they back. A good venture capitalist is anything but a passive investor.

Brentwood’s partners, on average, sit on five corporate boards each. Most are start-up companies, where board membership is often more a headache than a sinecure.

The involvement doesn’t stop at board membership. “I can’t tell you how many big and little crises (Brentwood’s) Kip Hagopian has helped us solve,” says Jack E. Shemer, chairman of Teradata Corp., a Culver City maker of database computer systems he founded in July, 1979.

As Teradata’s lead investor and “sponsor,” Brentwood rounded up other investors, introduced the company to potential customers and brought in a new president when technical and marketing snags brought the company to its knees in 1984.

Hagopian even came to Teradata’s plant to rally the troops after the company was forced to lay off 65 of its 200 workers that year. Teradata’s computers are now gaining market acceptance, and the firm employs 365 people.

“Every decision he has made has been focused on what is best for the company, rather than what is best for Brentwood,” Shemer says. “I consider him a partner.”

But the partnership did not come easily. When Shemer showed his business plan around in 1979, he recalls, “everyone asked, ‘If it is such a great idea, how come IBM isn’t doing it?’ ”

The skepticism extended to Brentwood. But the firm’s partners liked Shemer’s 20-year track record in the computer business at General Electric, Scientific Data Systems and Citicorp’s Transactions Technology unit.

“They did their due diligence, and were they ever diligent!” Shemer recalls. “They brought in hardware consultants, software consultants, marketing consultants. We had 15 meetings before they stepped up with their commitment.”

Indeed, if there is a criticism of Brentwood, it is that the firm is overly analytical--and sometimes misses out on good investment opportunities. “It is a very trying task to balance the sin of omission with the sin of commission,” partner Pennington says.

He winces when he recalls how Brentwood passed up a chance in the early 1970s to invest in Amdahl Corp., which grew to become IBM’s biggest competitor in the mainframe computer business.

The partners clearly relish their work, and not just for the considerable financial rewards. Like most in the industry, Brentwood charges limited partners an annual management fee equal to about 2% of the assets managed--and, more importantly, the firm keeps 20% of the profits.

Partners “earn well into the the six figures” and “can become independently wealthy,” a partner says.

Chance to Make Money

“There’s the chance to make a lot of money,” echoes Pennington, “but not as much as a successful entrepreneur.”

Still, Pennington wouldn’t trade places. “The variety of situations we get to experience is hard to beat: You’re always dealing with a different company, a different technology.”

“Rather than picking a stock and watching it, you are assuming responsibility for a company’s future and helping to determine the outcome,” he adds.

“Both the industry and the entrepreneurial world are populated by intelligent people who are exciting to be around,” partner Roger Davisson says. “Most of us are closet entrepreneurs--we get our thrills vicariously.”

But there are drawbacks. For one, venture capital investments are by nature long-term, “and the outcome is very long in coming,” Pennington says. Another drawback, he continues, “is that you can get a rather skewed view of the world. A company that is doing well doesn’t need your attention. The ones that can’t make payroll are calling often.”

Then there are the never-ending phone calls from supplicants wanting money. Of the 2,000 or so proposals the firm gets every year, more than half are rejected out of hand because the entrepreneur lacks a sound business plan or management team, or because the idea is outside Brentwood’s expertise.

The firm specializes in computers, electronics, communications, medical technology and devices and, to a lesser extent, retailing. Between 600 and 700 proposals are logged into the firm’s computer system for closer scrutiny every year, but only about 20 get funded.

“We are nervous and leery about publicity,” Pennington says. “The last time a story about us appeared, we got a bunch of phone calls at home--all with junk deals.”

SOME BRENTWOOD ASSOCIATES WINNERS

Date of initial Name of company Investment Cost Value* Leveraged buyouts: A.J. Industries Mar. 11, 1977 $250,000 $1.7 million Ideal School Supply July 24, 1984 $1.09 million $33.9 million Venture capital deals: Apple Computer Aug. 10, 1979 $1.13 million $23.9 million** NET July, 12, 1985 $2.6 million $15 million Network Systems Dec. 10, 1976 $396,000 $5.03 million

*At date of sale or distribution, or current value if still held

**Current market value is $70 million

Source: Brentwood Associates)