Hedge-Fund Investors Scout Out Web Firms

Date: Tuesday, July 12, 2011
Author: Spencer E. Ante, The Wall Street Journal

Spurred by their appetite for technology companies and seeking higher returns, a growing number of hedge-fund managers have started to invest more in private Internet companies.

When daily-coupon website LivingSocial Inc. said it raised $400 million in April, the firms putting up cash included hedge-funds Tiger Global Management, Lone Pine Capital and Brookside Capital, people familiar with the matter say. Tiger's name popped up again in late June, when the New York firm grabbed a piece of the $100 million financing round for Square Inc., a mobile-payments start-up led by Twitter co-founder Jack Dorsey.

A handful of hedge funds already had a history of such investments, but the activity has increased recently as investors try to cash in on the surging valuations of Facebook Inc., LinkedIn Corp., Zynga Inc., Groupon Inc. and a smattering of smaller companies

The inflows are giving young companies access to big pools of capital and the Rolodexes of some sophisticated investors. But they're also pushing the already frothy valuations of some companies even higher and rattling the clubby venture-capital scene. Hedge funds have typically invested in ventures that they can sell at a moment's notice, while venture-capital firms are known for advising start-ups and taking a longer-term view.

"Hedgies investing in start-ups directly is scary," says Jeff Clavier, founder of SoftTech VC, a small but influential seed-stage venture firm based in Palo Alto, Calif. "They are the antichrist of patient, supportive early-stage investing."

And there are risks. "There is a big experience curve" investing in start-ups, says Harvard Business School Prof. Josh Lerner. "It usually ends in tears."

Kevin Hartz is the chief executive of EventBrite Inc., an online ticket seller that announced a $50 million investment by Tiger in May. He says that he and other Silicon Valley entrepreneurs are by nature suspicious of money that comes from outside the Valley. But he says he came away from a meeting with Tiger impressed by its knowledge of China, India, Brazil and other markets outside the U.S.

"Sitting down with Tiger was an eye-opening experience," he says. "They understand those markets and know all of the different players."

In the past 12 to 18 months, firms including D.E. Shaw & Co., Maverick Capital, Brookside Capital and Tudor Ventures, as well as hedge-fund investor James Pallotta, have joined Tiger in putting more money into promising yet risky tech companies.

But Tiger has been especially active. Founded in 2001 by Charles "Chase" P. Coleman III, a protege of hedge-fund investor Julian Robertson, the firm launched its first private-equity fund in 2003. In 2009, it began buying large blocks of stock in companies like Zynga, LinkedIn and Facebook on the secondary market. Its 4.2% stake in LinkedIn, amassed at a cost of about $70 million, is now valued at nearly $400 million. (Mr. Coleman declined to comment for this article.)

Starting last summer, Tiger began ramping up its investments in private companies in India, China, Brazil, Russia and other emerging markets. This year alone, it has invested in six Indian start-ups, including consumer electronics retailer LetsBuy.com, online fashion site Exclusively.in, and online bookseller Flipkart.

Binny Bansal, co-founder of Flipkart, says Tiger's $20 million investment will help the company build out its logistics operations so that it can handle 15 to 20 times the number of orders it handles today.

Ilja Laurs is chief executive of GetJar, a start-up with offices in Silicon Valley and Lithuania that operates an online marketplace for wireless applications. It got $25 million from investors led by Tiger in February. Mr. Laurs says he appreciates that Tiger is comfortable in a passive role and hasn't taken a board seat.

Mr. Laurs says investors like Tiger have expanded his options. "An IPO used to be the only way to raise more than $100 million," he says. "If you need less than $1 billion, there are alternative sources available" now.

Edward Lampert, the hedge-fund investor who controls Sears Holdings Corp., has become interested in private tech companies too. He recently assigned Daniel Levine, an analyst at his hedge fund, ESL Investments, to look for opportunities.

This year, Mr. Levine attended two events hosted by start-up incubator TechStars to hear entrepreneurs pitch investors. ESL declined comment, but people familiar with Mr. Lampert's intentions say he is seeking firms that can benefit from connections with retailers like Sears.

Other investors, such as Mr. Pallotta, who once managed money at Tudor Investments and now runs Raptor Group, have a history of backing private companies. So far, he has put his own money in about 30 start-ups, including online video service Bedrocket and Web advertising provider Spongecell.

Now, he is starting a new venture fund, raising outside capital and setting a target of slightly less than $100 million, people familiar with the matter say. Late last month, he also launched a consulting business called Raptor Accelerator to advise the companies he invests in. The launch party was held at his New York office, an urban aerie that sits atop the Apple store on West 14th Street.

Ben Kartzman, chief executive of Spongecell, an Internet advertising start-up that received less than $1 million in financing last month from Mr. Pallotta and Google Inc. Executive Chairman Eric Schmidt, says Mr. Pallotta introduced him to an executive at a large media company, opening the door to a discussion about using Spongecell's technology.

"Jim has this set of really senior relationships," Mr. Kartzman says. "It's the kind of access I don't think we would have gotten."