For many of them, the downturn simply means the possibility of cheaper
prices for shares in the companies they're looking to invest in. Once,
venture capitalists could buy from 30% to 40% of a small company for abou=
t
$5 million to $8 million. But since the beginning of the year, the surgin=
g
stock prices have hugely inflated the price tags on start-ups, especially=
in
the later rounds of private funding. The result: increased risk for VCs,
especially if they can't generate colossal returns for investors used to
bigger and bigger yields.
Thousands of Employees Endure Wait to Turn Their Paper Wealth Into Cash
"The small companies have had a lot of people willing to invest without =
any
attention to valuation since returns have been so gigantic, and that make=
s
for bad investment decisions," said Roger McNamee of Integral Capital
Partners, who has been a vocal critic of overfunding nascent companies. "=
I
think a lot of people would love to see the herd get thinned -- without
causing extinction, of course." Every venture capitalist has his favorite
example of how out-of-control the values of start-ups were getting as Web
stocks surged. At a conference last month, Jim Breyer of Accel Partners
shook his head at the thought of $50 million to $60 million in new
investments going to each of several competing Web companies that sell pe=
t
supplies online. "I think it is just crazy," he said. Robert Kagle of
Benchmark Capital fretted about a huge $25 million first round that bough=
t
less than a 40% stake in Google, a year-old Internet-search company. The
infant business, competing in an already crowded field, previously garner=
ed
only about $1 million in seed money.
'Like Inherited Wealth'
"It's like inherited wealth," said Mr. Kagle. "Small companies can start =
to
spend indiscriminately and they quickly pick up bad habits that are hard =
to
correct later."
Benchmark became a Silicon Valley legend last year when it invested $5
million in Internet auctioneer eBay Inc. that turned into a $4 billion
stake. After that and a number of other such home runs for VCs, a lot of
start-ups wanted exorbitant prices for the stakes they were offering
Benchmark. "We walked away from some deals that we now regret because we
could not believe the prices," Mr. Kagle said. "The problem is there are
some really sound business plans that could really change their industrie=
s
encased in incredibly surreal financing." Some entrepreneurs, such as Ser=
gey
Brin, president of Google, disagree. He said the giant first round the
company got from two of Silicon Valley's best-known firms, Sequoia Capita=
l
and Kleiner Perkins Caufield & Byers was not the point. The money, "was n=
ot
as important for us as getting the right people involved," he said. He
contends that venture capitalists who have been more conservative have no=
t
benefited from the boom in Internet companies.
Many big venture firms are now getting ready for a another big shopping
spree, with a gusher of cash to play with. Last Thursday, the day Interne=
t
stocks dragged the Nasdaq Composite Index into an official correction,
Softbank Technology Ventures, an affiliate of Softbank Corp. of Japan, sa=
id
it raised $600 million for its latest investment fund to be aimed mostly =
at
Internet ventures. And Accel, based in Palo Alto, Calif., late last month
announced a $500 million fund that will invest in the technology sector t=
hat
took only two weeks to raise. It had attracted $1 billion in commitments,
said Mr. Breyer, allowing the firm to choose its investors carefully."We
even told them not to expect the returns of well over 100% that we have
delivered in the past, because we didn't feel that those returns were
sustainable," said Mr. Breyer, whose hit investments have included Intern=
et
multimedia software maker RealNetworks Inc. "But people still are very
interested in getting into this sector in any way they can."
VC firms have had such spectacular returns over the past few years, they =
can
weather a short slide. "It's incredible that if you sell a company off fo=
r
$100 million that's considered a loser," said Mr. Kagle. Frank Quattrone,
head of the Credit Suisse First Boston technology group, said it is natur=
al
for valuations to come down as the number of public Internet companies
grows. "Everyone wanted to own the category, but there were very few ways=
to
play it, so people said we're going to buy them all," he said. "Now the
supply is catching up and there have been tons of vehicles for investing =
to
play this trend, so it's time to figure out which of these players are go=
ing
to be franchise players and which are going to be laggards."
Integral Partners' Mr. McNamee said he hopes the downturn will help every=
one
sober up a bit from the nonstop party that has characterized the Internet
investment sector." It will take a sustained period of public market
disintegration to really stop the investing, which I think unlikely," he
said. "But this may make people focus on building real businesses, becaus=
e
it has been easy to confuse the bull market with brains."
Tushar J. Mehta
email: [email protected]
voicemail: (206) 405-2335