By Omar Akhtar
FORTUNE -- When he founded Greycroft Partners in 2006, Alan Patricof predicted resources would get cheaper and tech startups would need smaller amounts of funding to achieve the same levels of success. Six years later, the venture capitalist looks pretty clairvoyant.
Greycroft's business model of committing to a smaller-size fund and investing small amounts of capital in tech startup companies has proved successful. The venture capital firm recently closed its third round of funding at $175 million and reported stellar results from its first fund of $75 million in 2006 and its second at $130 million in 2010.
"We've committed to a small fund. That's the unique part of it," says Patricof. "And I think its working."
With 11 profitable exits so far, Patricof says the first fund has already given its investors more than three times what they put in and results from the second fund, while still too early to report, are already in the black. And there are still two to three new investments left in the second fund.
Some of Greycroft's notable exits include The Huffington Post, Paid Content and most recently Buddy Media, the social media marketing platform which was acquired by Salesforce.com for $689 million. Greycroft's initial investment in the company was only $1 million in 2008.
Patricof, a 40-year veteran of the venture capital industry previously made his name as one of the first investors in Apple and AOL. He was also the founding partner at Apax Partners, one of the world's leading venture firms with over $40 billion under management. In 2006, he stepped back from the large fund model to reassess what the market needed.
"What all of us had observed was that funds were investing more and more based on the size of the fund rather than what the capital needs were of these young emerging businesses," says Patricof. In response, Patricof and his partners set out to create a smaller fund that could invest small amounts in startups, who were taking advantage of cloud technology, outsourcing, greater broadband spectrum and open source code to operate more cheaply and efficiently.
"Smaller firms have an advantage to track, reach into and get involved with companies that would not necessarily get on the radar of the large mega companies," says John Taylor, head of research at the National Venture Capital Association. "They can be a real gold nugget for institutional investors."
Patricof's fund does things a little differently from most venture capital firms. Greycroft invests comparatively small amounts -- between $500,000 and $5 million -- in the early stage funding for a startup. The firm does not require a board seat, it almost always insists on bringing in a larger fund to partner with, and the end goal is for the startup to be acquired by a larger company rather than go public. This strategy may seem far-sighted, given how many tech companies had disastrous IPOs this year.
Fairview Capital is a venture firm that has invested in both Greycroft's second and third funds and also serves on its advisory panel. JoAnn Price, co-founder and managing partner at Fairview says Greycroft has been one of its top holdings. "Their performance at this point has been first quartile and we see them as a leader in their particular field."
Alan Mattamana, principal at Fairview, says Greycroft's model works because of its partnering strategy. "We see the model working in the way an angel fund or a seed fund couldn't. They wouldn't attract an institutional investor because their processes weren't as robust as Greycroft's," says Mattamana. Since Greycroft invests such small amounts and doesn't require a board seat, Mattamana says it is less threatening to its larger investing partners.
In addition to providing capital, Greycroft also works to bring portfolio companies and potential buyers together to facilitate a buyout. "The companies in our business are typically bought, not sold," says Sigalow. "Over the course of time, there are year-plus conversations where the big acquirer falls in love with the business, and we can help with those conversations," says Sigalow. "We know the heads of corporate development at every big single major media/tech company."
The company also organizes "Digital Days," where entrepreneurs can meet and network with potential buyers. Founding partner Dana Settle, who heads the company's Los Angeles office, says the meetups are the best way for startups to gain early exposure. "There's a massively inefficient information flow. Our job is to make those connections and provide credibility," says Settle. "We make sure they're on the radar screens of those big companies, not to sell them, but to show that they exist."
Two years ago, Greycroft also set aside $5 million out of Greycroft II for seed investing. One of the companies who benefitted from the money was Pulse, the news reading app for mobile and tablet devices created by Stanford graduate students Akshay Kothari and Ankit Gupta. Kothari says Greycroft invested $100,000 in the startup after a chance meeting with Patricof and Settle in a Palo Alto coffee shop. They have continued to mentor Pulse since.
"Alan Patricof is like your strict father," says Kothari. "He'll sometimes be hard on you, but he deeply wishes the best for you and your career. He thinks of Pulse as his own company -- I can't count the number of days he's called me at 2 a.m. New York time with an idea."
Greycroft's latest area of interest is online video. Partnering with other VC firms, it recently invested $5 million in the web video service Longtail Video and more than $4 million in viral video creators Maker Studio. Settle says the firm originally passed on the first wave of web video startups but is now investing due to better monetization and distribution models led by YouTube. "We started to see that YouTube had a model where original content creation companies essentially build businesses on their back." says Settle. "You didn't have to build a sales force, you could just incubate there."
Since it's located in New York and Los Angeles, Greycroft is focusing on local companies, with video content talent in Los Angeles and advertising/digital media talent in New York.
"There will be larger acquisitions further away from San Francisco as the traditional acquirers branch into new markets seeking companies that have large labor bases," says Sigalow. "It becomes an asset, not a liability to be located in a hot city where they can hire more people."
A group of venture capitalists and private equity investors discussed the challenges and rewards of early and late stage investing in web companies today. Fundamentally, the game hasn't changed: You can't win if you can't pick winners.
Panelists: Adam Clammer, head of technology group, Kohlberg Kravis Roberts; Bill Maris, Managing Partner, Google Ventures; Henry Ellenbogen, Portfolio manager, T.Rowe Price; Jerry Murdock, Special Limited Partner, Insight Venture Partners; Mike Maples, Managing Partner, Floodgate; Dana Settle, Partner, Greycroft MOREJul 20, 2011 6:20 PM ET
|Microsoft unveils new Xbox One game console|
|Apple grilled about tax havens|
|Stocks end at record highs ahead of Bernanke|
|The market doesn't lie: Housing recovery is real|
|Make $30 an hour, no bachelor's degree required|