Last year I attended a conference of technology companies at which the fo=
cus
was Japanese billionaire Masayoshi Son and the businesses in which he and
the Japanese holding company he controls, Softbank, have invested. Most w=
ere
Internet companies; the most successful of them was Yahoo -- an investmen=
t
in which Son had made $2 billion. For two years the Silicon Valley old
guard -- professional investors used to funding networking companies and
chip factories -- had scoffed at Son, ridiculing the prices he was paying
for his Net investments.
At this conference, however, Masayoshi was basking in triumph. He owned a
third of the stock in Yahoo, then a $6 billion company. He owned a third =
of
GeoCities, too, a Web-hosting service that had inspired the public market=
s
to go gaga (and which has since sold out to Yahoo). Son was finally being
accepted as what he wanted to be: a true Net mogul. As Son spoke, slides
flashed on a screen behind him. There were slides with circles, slides wi=
th
line charts, slides with equations and summation signs. But there was one
particular slide that got the audience palpably excited. It showed a smal=
l
square with the names of some old school industrial companies written bel=
ow
it, a bigger square with new companies like Dell Computer, a still bigger
square with the names of huge media companies, and a last, biggest square
with the next wave of Net companies. The squares were supposed to represe=
nt
the relative values of each generation of business giants. And the point,
ultimately, Son claimed, was that the top companies of the Net generation
would have a market value 10 times that of their predecessors. Of course,=
it
was all hype. But the audience loved it.
I could not help thinking of Masayoshi Son earlier this month when three
investors -- Son's Softbank, plus the investment bank Goldman Sachs and t=
he
venture capital firm Sequoia Capital -- let it be known that they had pai=
d
$275 million for 6.48 percent of the stock in Webvan. Webvan, as many
readers of the business pages know, is an online supermarket headed by Lo=
uis
Borders, founder of the Borders chain of bookstores. Webvan currently
delivers groceries to customers in the San Francisco Bay Area. In investm=
ent
speak, Webvan is a national online retail play trying to capture a big pi=
ece
of the $350 billion dollar a year grocery market. But more precisely, Web=
van
right now is a very big warehouse in Oakland, Calif., a headquarters offi=
ce
in Silicon Valley, an attractive logo, a fleet of trucks, some 300
employees, a computer system that links all these pieces together with an
e-commerce Web site, a contract with construction giant Bechtel that comm=
its
the fledgling company to building 26 more warehouses at a cost of $1
billion, and a lot of hope. That's it. Six and a half percent of this is
worth $275 million, which gives the whole thing a nominal value of $4
billion. That's an awfully pricey warehouse.
If you are scratching your head wondering how a warehouse with operations=
in
just one small part of the country can be worth so darn much money, howev=
er,
you're probably wasting your time. There are certainly ways to calculate =
the
potential value of the business. You can look at the value of Safeway, th=
e
giant grocery store chain, whose stock has a total value of $26 billion
plus. You can, conversely, look at Peapod, the first online grocer, a
service that the Wall Street Journal plugged in 1994 with the headline
"Peapod's On-Line Grocery Service Checks Out Success," whose stock is
muddling along at a single-digit share price. You can talk about profit
margins and argue about whether online groceries will succeed in achievin=
g
the 5 percent profit margins they hope for -- though most backers of onli=
ne
groceries will tell you that traditional supermarkets have margins of jus=
t 1
and a half percent and Safeway's are at 3 percent. The problem is that al=
l
of this entirely misses the point.
In fact, there is one overriding reason why this warehouse in Oakland is
worth $4 billion: The money managers who have invested in Webvan have
already made a whole lot of money in other Net companies. And so, like So=
n
at his conference, they give the entire project a halo of invincibility, =
no
matter how preposterous the financial assumptions. Those money managers a=
re
two Silicon Valley venture capital firms, Benchmark Capital and Sequoia
Capital. Venture capitalists right now are the darlings of the business
world. In fact, to call them simply "money managers" is asking for a figh=
t.
Venture capitalists insist that what they do is not manage money but buil=
d
companies, and this is partly true. They certain provide management advic=
e,
some of which is good; they help recruit employees; and they contribute, =
to
the best of their abilities, at board meetings. But their reason for
existence is, put bluntly, managing money, much of which represents the
investments of university endowments, pension funds and some of the large
number of extraordinarily wealthy individuals. They invest this money in
companies -- including many technology companies -- at an early stage of
their development, hoping to multiply their funds 10- or 20-fold with eve=
ry
successful investment.
In Silicon Valley there is a definite pecking order among venture capital
firms, and Sequoia and Benchmark are near the top, getting into the most
sought-after deals. (Kleiner Perkins Caufield and Byers, which made its
money and its name on early investments in Netscape and Amazon.com, has l=
ong
been at the pinnacle.) Sequoia and Benchmark are on top now largely becau=
se
each of them has had a single stunningly successful Net investment. For
Sequoia, it was Yahoo; Sequoia provided $1 million of startup money for a=
25
percent ownership in the company; Yahoo's stock is now valued at $26
billion. Michael Moritz, the Sequoia partner responsible for backing Yaho=
o,
is also the partner who sits on Webvan's corporate board. Meanwhile,
Benchmark is one of Silicon Valley's younger venture capital firms -- jus=
t
four years old. Benchmark was the initial investor in the auction site eB=
ay;
its share is now worth about $880 million. But here's the big irony of th=
e
Silicon Valley pecking order: The biggest advantage of having backers fro=
m
the club of top money managers is the mystique they bring. By their vote =
of
confidence in a company, the top venture capitalists attract other
investors, who put in even more money in later rounds of financing. Webva=
n
counts as investors not only Softbank and Goldman Sachs, but also the Fre=
nch
billionaire Bernard Arnault, newspaper company Knight-Ridder and CBS. All=
of
them have ponied up tens of millions in financing to go along for the rid=
e
with Benchmark and Sequoia.
Well, guess what. Once a company has raised over $400 million, it's almos=
t
certainly only a very short step away from selling stock to the public.
Chances are that investors will bite once business magazines report that =
a
company has a "value" of $4 billion. What that means is that the last 6.4=
8
percent of the company was sold for $275 million, which implies that the
whole company is worth $4 billion dollars -- even though Benchmark and
Sequoia got big pieces of the company early on, for much, much less. If t=
he
company does go public, the investors in the public markets will no doubt=
be
eager to get stock in a company that comes with the imprimatur of gilt-ed=
ged
money managers. On top of it all, the fact that Webvan and Yahoo share
Softbank as an investor (in fact, Yahoo CEO Tim Koogle has a seat on
Webvan's board of directors) implies a deliriously full future for invest=
ors
eager to bet on the future giants of the Net.
A scenario a lot like this played out last week, when investors bid up
shares in Drugstore.com, an online pharmacy backed by Amazon.com and Klei=
ner
Perkins, the most prestigious and powerful of all of Silicon Valley's
venture capital firms, by 179 percent in one day. The stock of
Drugstore.com, a company that opened for business five months ago, is now
worth just over $2 billion. (Amazon and Kleiner Perkins have also teamed =
up
on a direct competitor to Webvan -- HomeGrocer, which is already operatin=
g
in Seattle.) There is not a single venture capitalist who does not say th=
at
his goal (they are mostly men) is building "the next Microsoft." But here=
's
the ugly truth: It makes no difference to a venture capitalist's returns =
if
a company grows to dominate an industry or goes bankrupt five years after
selling stock to the public. A Boston Market (formerly Boston Chicken) ca=
n
be as good as a Microsoft because a venture capitalist needn't wait for t=
he
company to prove itself; not long after a company goes public, the ventur=
e
capitalists can cash out. In fact, a Boston Market -- a high-flyer which
went bankrupt -- can be better than a Microsoft, because all of Microsoft=
's
stock taken together wasn't worth a billion dollars until the company had
been around for nine years.
What venture capitalists are looking for is -- don't laugh -- a "liquidit=
y
event." That's biz speak for selling a company or taking it public, turni=
ng
their ownership stake into cash. Typically, a year after a company goes
public, venture capitalists are allowed to sell their stake. Sometimes th=
ey
will do that. More often the venture capital firm will split the stock up
among investors in its fund, letting them quietly sell it in small bits a=
nd
reap huge winnings. Or they might hold it, if the investors think the
company really will be the next Microsoft. The upshot is that venture
capital firms are not in the business of taking a long time to build
companies. At one time, they might have been, but that is certainly not t=
rue
in the age of the Net. Like Masayoshi Son at the San Francisco conference=
,
they are in the business of retailing dreams of corporate grandeur. If th=
ey
succeed in selling those dreams, they can make a lot of money. Whether th=
ey
come true, however, rarely need be their main concern.
Tushar J. Mehta
email: [email protected]
voicemail: (206) 405-2335