New York—A friend who is raising capital to start a new research firm has found venture capital funds less than enamored with the alternative research industry. Many, if not most, VC firms hold the conviction that independent research firms are bad investments, condemned to be small boutiques. We used this opportunity to look through our database to see whether the VC bias is justified. A related question is whether Goldman’s investments in alternative research disprove the VC firms’ caution, or whether the VC firms will have the last laugh.
Bessemer Venture Partners has done very well so far with its investment in Gerson Lehrman Group (GLG). Bessemer invested in February 2004, reportedly investing $20 million of a $30 million raise. At that time, GLG was approximately $80 million in revenues, and now tops $200 million in revenues, more than doubling Bessemer’s investment. The key for Bessemer is the exit, of course, and periodic regulatory scrutiny of expert networks makes the exit a bit trickier than it would otherwise be for a firm with GLG’s growth. Nevertheless, we expect that Bessemer will ultimately profit handsomely from its investment in GLG.
When Bessemer invested in GLG, VC interest in alternative research was relatively high. Two months prior, TA Associates had invested $60 million in the Center for Financial Research and Analysis (CFRA), a prominent forensic research firm. Majestic Research raised $7 million in a Series A financing led by BV-Cornerstone in February 2005. Prior to its investment in GLG, Bessemer had invested $6 million in Soleil Securities in October 2003, and participated in another $11 million raise by Soleil in March 2005 led by Bain Capital Ventures.
VC enthusiasm was influenced by the Global Research Settlement, which set aside $460 million for the purchase of independent research beginning in July 2004, even though the firms receiving investments did not participate directly in the Settlement. It was hard to escape the hype around independent research.
Current VC skepticism is founded in the mixed results from the initial rush to fund alternative research. TA Associates recently sold its stake in CFRA to Riskmetrics, reportedly at a price equivalent to its initial investment. Majestic is in the market for a Series B financing has dragged on for months. Soleil has grown very nicely, but is not highly profitable because of the large payouts it makes to the research firms on its platform.
There is no question that investing in investment research is a tricky proposition. The field is very crowded, and, despite repeated forecasts of consolidation, it continues to expand. Given the proliferation of research providers, achieving size and scale is difficult. A search of our database indicates that less than 2% of the 500+ alternative research firms we track have revenues in excess of $15 million.
So is Goldman Sachs misguided in making minority investments in alternative research firms? Goldman’s approach is different than that of the VCs in a few of respects. Through its Hudson Street venture, Goldman is taking minority stakes in the firms. It is contributing distribution (in return for exclusivity), helping to grow the top lines of the firms. Early reports are that at least a few of the research firms are benefiting from GS distribution efforts. And the investments have a strategic character, helping GS to diversify its research offerings in a time of increasing unbundling of equity commissions.
Received VC wisdom is colored by its earlier exuberance in 2003 and 2004. It is accurate in perceiving investment research as a challenging market, despite continued regulatory leveling of the playing field between alternative and Street research. However it ignores VC successes with firms like GLG and Creditsights. The problem for VC firms is that successful investment in the research industry requires strong domain knowledge of the industry which most VC firms lack. VC firms, like Bessemer, BV-Cornerstone and others, which have made the effort have had good success with their investments.
Doug Atkin informs us that Majestic Research withdrew its Series B financing because its business was growing at a rate that made it unnecessary to raise capital. This is good news, and an excellent outcome for Majestic. According to Doug “In 2007, due to a great effort by our entire team, Majestic grew the top line by almost 50% and is now solidly profitable- generating both EBITDA and positive operating cash flow. What distinguishes us from other research firms is our ability to leverage technology to build a very scalable business and most importantly produce a unique product that is valued by over 150 of the most sophisticated global fund managers.”