Source: Fortune Magazine, December 6th, 1999, edition
This message contains Parts IV, V and VI (of a six-part article)
Nice Work If You Can Get It
In an age of easy money, the clubby world of venture capitalists has given
way to something more aggressive and cutthroat.
By Melanie Warner
© Copyright 1999 Time Inc.
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(continued)
In this age of an endless supply of easy capital, VCs must compete for
deals. Money alone won't cut it anymore. You have to prove that your money
is better than everyone else's. Entrepreneurs want to hear about your "added
value." Will you recruit, make calls on their behalf, sit in on staff
meetings, have breakfast at Buck's with strategic partners at 7 a.m., and
answer your home phone when it rings at 10 p.m.? If yes, then maybe you can
invest. Maybe. Jay Hoag is sitting in his office in Palo Alto showing me his
new logo. Since starting Technology Crossover Ventures in 1995, Hoag hasn't
had much of a logo at all really, just the firm's name punctuated with a
thin red line. But earlier this year he and his eight partners decided they
needed to make more of a statement. "We wanted something that indicated
success and stability but was also pretty simple and straightforward," says
Hoag, who spent 12 years at Chancellor Capital Management before breaking
out on his own. So he hired a design firm to redo his firm's Website and
come up with the new look and logo, a multicolored assemblage of letters and
a giant green swooshing arrow. "You have to be more promotional and pound
your chest," Hoag explains. "VCs have to build a brand. It's the price of
admission." VCs never used to talk about their "brand." If they had one,
they certainly didn't refer to it in public or consider it a part of
official business. Venture capitalists didn't hire PR firms; their idea of
marketing was to repolish the sign over the door or throw a Christmas bash
at the Menlo Circus Club. That worked when the entrepreneurs were doing most
of the selling. It doesn't work now that a certain subsection of company
founders can walk down Sand Hill Road and collect term sheets from whomever
they please. In that environment VCs have to ask themselves this
soul-searching question: Why should someone take my money?
To help the world answer that question, Hoag hired a PR firm called Blanc &
Otus, which proceeded to get him on Wall Street Week with Louis Rukeyser.
Hoag also went on CNBC for CNET's news.com show. He wrote a column for The
Red Herring magazine. In the interest of branding, he also joined the board
of iVillage just before its IPO. TCV was already an investor in the women's
portal, but Hoag knew there'd probably be a lot of attention surrounding the
IPO and figured some of that attention would reflect well on him. "When
you're a board member, people take it more seriously, even though it doesn't
necessarily indicate anything about your contribution," says Hoag. Branding
himself isn't exactly the witty, self-effacing 41-year-old's idea of fun,
but he feels the business demands that he do so. "There's a lot of people
with capital," he says. "You have to differentiate yourself." Despite his
misgivings, Hoag has proved pretty adept at the marketing thing. He was
amazed when a succession of entrepreneurs marched up to him with their
laptops at this year's Agenda conference and implored him to spend 15
minutes listening to their PowerPoints. And in a sign that TCV has really
made it, several companies have come offering "last looks." They already had
term sheets from what they considered B-list VCs but were willing to let TCV
invest at a lower price. TCV's new profile also helped Hoag get into the
Petopia deal. No one's quite sure why, but seven months ago a rash of
companies arose with plans to sell pet supplies online. Pet portals, it
seemed, were the next new thing in e-commerce. Every VC in the Valley had to
have one. Hoag bought into the enthusiasm and homed in on Petopia. But there
was competition. When he first met with Petopia's CEO, Andrea Reisman, she'd
already had an audience with nine VCs and had come within days of doing a
deal with one. But Reisman liked Hoag's candor. She also liked the fact that
TCV often continues to invest in its portfolio companies after they go
public. That's what accounts for the Crossover in the firm's name. In
addition to its private-venture deals, TCV invests in the public markets and
recently set up a separate fund to do more of it. It's a selling point, part
of TCV's "added value." Entrepreneurs like the idea that their VC, a
friendly investor if ever there was one, would own their post-IPO stock.
That's a nice alternative to day traders who pile in and then flee and to
institutional investors who buy IPO shares and then flip them. Reisman
ultimately let Hoag put in $9 million and take the whole round. Just about
every other pet portal got funded too. Pets.com got $60 million from Amazon
and Hummer Winblad; Petsmart took $10 million from Idealabs Capital
Partners; and Petstore raised $10.5 million from Battery Ventures and
Advanced Technology Ventures. Petopia, for its part, spun around two months
later and raised $66 million from Petco and French luxury-goods seller LVMH.
One VC who didn't look at funding a pet portal is Mumford. Crosspoint's
deals in the past three years have fallen into three distinct
categories--Web-based enterprise applications and services like Ariba,
next-generation carriers like DSL company Covad, and business-to-business
Net exchanges like National Transportation Exchange. Crosspoint has never
funded a consumer Website. No finance portals, no MP3s, no online furniture.
Mumford knows he's missing out on boatloads of money, but he "just can't get
comfortable" with the businesses of most dot-coms. Mumford, who grew up in
an age when technology investing meant investing in technology, doesn't
understand the dynamics of banner advertising or of sites trying to sell
watches or makeup. He doubts that those businesses will ever make real
money. And isn't that still, after all, the point of starting a business?
For all his deliberate snubs of consumer e-companies--or "foo-foo dot-coms,"
as he takes great amusement in calling them--Mumford decided earlier this
year to jump into the action. He chose online home improvement, because if
there's one business Mumford knows, it's hardware: He's built garages and
wired basements, and figures he owns more bags of nails than any other VC.
The young CEO of HomeWarehouse.com, Richard Shane, seemed smart and
charismatic, and Mumford liked him immediately. After two weeks of meetings,
he and Shane had a handshake deal. Then Mumford got cold feet. He was
sitting in his Woodside office one afternoon thinking about the deal, and
doubts flooded into his head. Hopping into his 1997 Aston Martin, he went
home, put on a denim jacket, and headed over to Home Depot in San Carlos. He
walked around the store and talked to customers, eager to know how many
might buy hardware online. The results were not good. About 80% didn't own a
home PC, and just about everyone he talked to said that he saw no reason to
buy hardware online. The next morning Mumford called Shane and pulled out of
the deal. He'd decided that the online market for hardware wouldn't be that
big, and that he didn't see how the company could take enough costs out of
the system to make money. "When you put all the infrastructure back into
these companies--delivery, distribution, and call-center support--it gets
very expensive," says Mumford. "At some point the hype stops, and earnings,
performance, cash flow, market share, and growth become the factors you've
got to settle down and value these companies on." Even if he's right about
HomeWarehouse.com, Mumford knows he probably could have made money on the
deal. If HomeWarehouse does everything right, and if the public market's
enthusiasm for e-commerce stays high, there's no reason to think that the
company can't go public with a billion-dollar valuation. And when that
happens, Sequoia and Accel, the two VCs who stepped in after Mumford jumped
ship, will make hundreds of millions of dollars. But whether HomeWarehouse
can ever make money is another question. Since the stock market doesn't
expect young Net companies to be profitable or even show much revenue, lots
of them go public before their businesses have ever been tested. Just when
will they be tested? Probably long after VCs and other private investors
have distributed their chunk of stock among themselves.
That is one rule of the venture game that makes playing it so lucrative: If
a company goes public at all, VCs make money. Venture capitalists are part
of a very active food chain. Since their money goes in first, they sit at
the top of it. As long as someone else is willing to come along in the
public markets and pay a generous multiple of the original price, the VCs
will do quite well. If the stock later deflates, it's not the VCs who'll be
holding the bag. "You want to be the second-to-last fool," says Bill
Davidow, the 64-year-old founder of Mohr Davidow. Does that mean that what's
good for VCs is bad for the investing public? In some cases, yes. That's not
to say that funding Internet companies constitutes some kind of New Economy
Ponzi scheme. Most VCs don't fund companies that haven't a prayer of turning
a profit. They believe that, while it may take years and untold millions,
the companies they back will sell high enough volumes of goods or find
enough creative ways to capture ad dollars to live up to the promises laid
out in their business plans. Jon Callaghan certainly believes that the 36
consumer dot-coms and ten business-to-business Internet companies his firm,
CMGI, has funded in the past four years will be able to do that. "We're
completely devoted to our companies long-term, and we certainly expect them
to become huge successes for everyone who invests," he says, with such
pleading earnestness that you want to believe too. Few have been doing more
Net deals than Callaghan and his eight partners at @Ventures, the Silicon
Valley venture arm of Boston's CMGI. This year it has been on a tear, adding
about four new Internet companies a month to the growing "CMGI family." For
every imaginable market in consumer e-commerce and Web content, @Ventures
has a company--sporting goods, cars, crafts, watches, ticket sales, expert
advice, genealogy, you name it. One of the Valley's youngest VCs,
Callaghan, 30, joined CMGI at just the right time. Few people had heard of
the company when he was offered a partnership fresh out of Harvard Business
School in 1997. Some MBA friends thought he was crazy to turn down offers to
be an associate at several of the Valley's better-known VC firms. But
Callaghan's boss, CMGI CEO David Wetherall, had discovered the joys of
Internet investing after his $4 million investment in a little search engine
called Lycos swelled into $1 billion, and was in the process of turning CMGI
into one of the most admired brands in venture capital. Between the 12
properties owned by CMGI (the biggest is AltaVista), and the 52 companies in
Callaghan's portfolio, CMGI claims to have the fourth-largest audience of
any Internet company (MediaMetrics backs him up on that). This reach is
Callaghan's "added value." Several times a year he holds summits where execs
of the CMGI companies gather. Callaghan says that at a recent powwow in
Scottsdale, Ariz., more than 20 deals were done among the companies.
AltaVista, for example, reserved slots on its site specifically for some
CMGI and @Ventures companies. The last boom cycle in venture capital lasted
about five years. In the late '70s and early '80s the business got frothy,
lots of new firms piled in, and every VC was really happy. Then the market
for small-cap stocks blew up. It became difficult for VC firms to raise new
capital, and those eager new VCs went off to do something else. While the
Internet may change everything, most VCs who are old enough to remember the
last cycle know it can't stay this good forever. Mumford, for one, remembers
having to crawl on his knees to raise money for funds. That's why he
recently spent three days flying around the country to visit each of
Crosspoint's limited partners. He could have raised his $600 million by just
picking up the phone, but he wants his investors to think favorably of
Crosspoint when the rainy days come. "If the market gets really ugly, those
with money will be kings," agrees Hoag, who acknowledges that insurance
against such dark times is one reason TCV is considering raising a
billion-dollar fund. Zachary contemplated this back in September as he
stared at all the VC wannabes at the Sand Hill Challenge. "As long as
everything's going up, you're foolish not to invest," he said. No one's
ready to stop partying just yet. The music, you see, is still playing.
(parts I, II and III of this article sent separately, in a single message)