Everybody wants to be a venture capitalist. And no wonder: VCs are raking=
in
money as never before. As of posting time, the stock that each Benchmark
partner held as a result of Benchmark Capital's $5 million investment in
eBay (Nasdaq: EBAY) in 1997 was worth more than $150 million.
Almost incredibly, however, if the market for Internet stocks does not
suffer a significant decline, venture capitalists could get much, much
richer. Several VC firms have raised their rates. And the rumor is that
Benchmark's partners will keep contributions to their next fund to
themselves. Has success gotten the better of the VC world? I don't think
so. In its latest fund of $480 million, Accel Partners has convinced its
investors to pay a 30 percent "carry." That means 30 percent of the gains
made by a limited partner on
its investment in Accel's fund will go straight to Accel's general partne=
rs.
Accel joins a select club of firms -- including Benchmark, Sequoia Capita=
l,
and Kleiner Perkins
Caufield & Byers -- that are now charging a 30 percent carry, up from 25
percent only a short time ago. These firms probably deserve larger carrie=
s.
According to sources, they have delivered returns averaging more than 100
percent for the past several years.
YOUR MONEY'S NO GOOD HERE
At the same time that these funds are raising their rates, some are reduc=
ing
the percentage of capital that their limited partners can invest in their
funds. In the past,
each general partner typically anted up one percent of their fund's total
capital. But partners at Accel and the Mayfield Fund contributed a total =
of
10 to 20 percent of their firms' current funds, significantly more than o=
ne
percent per partner. There are many reasons why it makes sense for genera=
l
partners to put more of their own money into funds. In addition to receiv=
ing
a higher percentage of the returns, they are aligning themselves more
directly with the interests of both their limited partners and the
entrepreneurs they back. According to Professor Bill Sahlman of the Harva=
rd
Business School, "There's a lot of evidence that having general partners
invest is a good thing."
Nevertheless, reserving a fund for partners and possibly a select number =
of
entrepreneurs is highly controversial. Kevin Fong of the Mayfield Fund
thinks VCs benefit from the discipline of discussing and analyzing their
investments with limited partners such as endowment funds and pensions.
Another VC, who requested anonymity, was even more blunt: "It's a short-t=
erm
strategy. Investment cycles go from fear to greed. Today, every company i=
s
going public. But this cycle of greed will change." In his view, VC firms
will inevitably need capital, and institutions are long-term
players.
LIMITED INPUT
Although no partner at Benchmark would confirm or deny this story, reliab=
le
sources have told me that Benchmark is considering limiting the investmen=
t
its limited partners can make. I think it's a good strategy, and here's w=
hy:
although VCs would lose the benefit of the wisdom of pension-fund manager=
s,
"most VCs don't want to talk to their limiteds anyway," says Mr. Sahlman.
True, this kind of fund might not be able to survive a severe downward
correction, but venture capitalists should take risks. The only real stri=
ke
against this strategy is that venture firms might alienate the very same
strategic corporate investors that have invested in their firms. But many=
of
these companies invest in startups themselves on the side; the main purpo=
se
of their VC investments is to get a first look at new technology from a
top-tier VC firm, not generating a financial return. The inescapable fact=
is
that partners kicking out their limited partners is just a natural extens=
ion
of the larger stakes that they are already taking in their funds.
"Investing more of their own capital keeps VCs focused," says Georganne
Perkins, an investment officer at Stanford Management Company, which mana=
ges
Stanford University's endowment -- one of the very institutions that coul=
d
be threatened by these kinds of changes.
This funding structure could also bring some additional benefits. Accordi=
ng
to Mr. Fong, the substantially more favorable returns that VCs would rece=
ive
if they reserved
their funds for themselves could enable them to work with smaller funds a=
nd
still make a killing -- and as a result, spend more time with fewer
companies. Although some VCs have become just as self-indulgent and
self-important as investment bankers in the late 1980s, partners taking
larger stakes in their funds makes a lot of sense. The more that VCs alig=
n
themselves with the interests of entrepreneurs, the better.
Tushar J. Mehta
email: [email protected]
voicemail: (206) 405-2335