Venture Capital--the New Gold Rush
Not so long ago, no one was much interested in what Paul Nadel does for a living.
But now when he tells people that he is a venture capitalist, business plans materialize out of back pockets and are pushed into his hands.
“They are what scripts used to be in this town,” says Nadel, a partner in East-West Capital, a $250-million Los Angeles-based venture fund that has invested in nearly 30 young companies.
In the “new economy,” the venture capitalist has become the gatekeeper of the entrepreneurial culture. Part financier, part coach and part visionary, venture fund managers such as Nadel are providing the money and advice that is breathing life into the dreams of an unprecedented number of entrepreneurs.
Buoyed by the successful start-ups of hundreds of technology companies in recent years, venture capitalists are enjoying a bull market that extends beyond their investment portfolios.
Their numbers now are swelling with entrants eager to copy their success, and an army of investors large and small is shoveling massive sums of money their way, betting on a continuation of the stellar venture returns of the late 1990s.
But the venture boom may be rapidly sowing the seeds of its own destruction. Some experts argue that there is simply too much money flowing to too many fledgling companies that have little chance of becoming real businesses.
“It’s easier than ever for a company to raise money, and lots of it. The danger of that is that a bad idea can raise a lot of money,” said Bill Burnham, a former analyst at Credit Suisse First Boston who left the investment banking firm last year for Japan-based global venture giant Softbank.
“There are probably more companies founded on bad ideas than ever before,” he warned.
The remarkable returns on venture investments in recent years have stemmed from the willingness of institutional and individual investors to pay gigantic premiums for the businesses that venture investors initially fund. A $10-million venture investment, for example, might yield a payoff five or 10 times that amount if the company can sell shares on Wall Street or be sold to a larger firm.
Enticed by a seemingly insatiable public demand for new stocks, the number of venture investors large and small continues to mushroom.
And though it hasn’t reached Silicon Valley proportions, Los Angeles is increasingly becoming a venture hub. “VCs” and “dot-com” executives here now qualify for movie star treatment.
Entrepreneurs and financiers alike flock to venture networking events.
A sold-out crowd of nearly 2,000 showed up Wednesday at a Los Angeles Venture Assn.-sponsored conference to hear local entrepreneurial success stories, such as Westlake Village-based NetZero. At one “Zone Club” event, put on by Los Angeles venture fund Zone Ventures, cars lined up to get into the parking lot at the Museum of Science and Industry for a schmooze fest that had all the makings of a pickup scene for thirtysomethings. Nearly 1,000 entrepreneurs and finance types showed up.
“I’ve been handed business plans in a restaurant, in a taxi,” said Frank Creer, managing director of Zone Ventures, which just raised $100 million for its second venture fund and sponsors the Zone Club and its own magazine devoted to local entrepreneurs.
“I feel like the only woman at the prom of an all-boys school,” said Joe Reece, who left Wall Street investment house Donaldson, Lufkin & Jenrette last year to set up Santa Monica venture firm Encore Partners.
The firm has raised $150 million from investors, has already financed nine fledgling companies and just opened a Dallas office. Reece, 38, said he and partner Steve DesJardins look over about 100 business plans a week.
In a typical venture deal, a small, privately held business gets a large cash infusion and in return gives the investors a major ownership stake. The venture fund partners may become very active in the business, recruiting management and even changing a company’s focus.
The goal is always the same: Get the company launched--and, ultimately, sold.
When venture capitalists recognize a hot idea, the score can be huge. A $6.5-million investment in EBay in 1997 by Benchmark, a Silicon Valley venture fund, by early 1999 was worth more than $5 billion, an increase of nearly 77,000%, after EBay’s public stock offering in 1998 and the shares’ subsequent surge.
Last year, venture funds averaged returns of nearly 100%. Some deals produced 1,000% or greater returns.
In search of payoffs like those, a record $50.7 billion in venture money poured into new companies nationwide last year, more than double the amount in 1998, according to Venture Economics, a New Jersey data firm.
Venture investments in Southern California also more than doubled.
Venture Funds Now Seen as ‘Sexy’
Venture capital firms have been around for decades. The Silicon Valley firm of Kleiner Perkins, and partner John Doerr, considered the king of venture capitalists, started in the 1970s.
But never has venture capital been as sexy: It now ranks near the top of the career-choice lists on most college campuses--right after dot-com entrepreneur.
Peter Wendell, a partner with $500-million fund Sierra Ventures, teaches a new course at Stanford University called Entrepreneurship and Venture Capital. The course is so packed, he said, that students are practically “hanging from the rafters.”
And no wonder. “You’re a little like the local celebrity,” said Len Batterson, a founding investor in America Online who last year launched VCapital, a Chicago Internet company that connects entrepreneurs with money people. “I was sitting at my local Starbucks, and all my neighbors were coming up to ask me, ‘What’s the next new thing?’ ”
Successful venturists say the current glamorous image of their field belies the extraordinary amount of work involved in identifying ideas that make sense.
Brad Jones, arguably Los Angeles’ most prominent venture capitalist, said that on a typical day he’ll hear pitches from three or four companies, some Internet spinoffs by well-established firms and others with ideas for products that sound like something from “The Jetsons.”
The hardest part is saying no nicely, he said.
“I try not to be the Hollywood type that never returns phone calls,” said Jones, a managing director of the $600-million Redpoint Ventures fund and managing partner at Brentwood Venture Capital. “I try to get back to every entrepreneur within two days and to be honest about what we think.”
The reality is that, even in the current venture boom, most ideas go unfunded. Indeed, out of the torrent of business plans sent to venture capitalists, anecdotal evidence suggests only about five of every 1,000 plans get funded, venture capitalists say.
Yet the sheer volume of dollars available is helping sustain the technology company boom that has captivated Wall Street.
Primary Sources of New Capital
Most venture money today comes from three primary sources:
* Traditional venture funds such as Kleiner Perkins and Brentwood Venture Capital, which are formed by partners who raise millions from pension funds and other institutional investors.
Some established entrepreneurs have created their own funds as well. James Barksdale, the former head of Netscape Communications, and David Bohnett, who sold Santa Monica-based GeoCities to Yahoo Inc. last year, have launched funds focusing on Internet start-ups, as have Microsoft founders, Bill Gates and Paul Allen.
* Corporate funds formed by “old-economy” companies, such as accounting firm Arthur Andersen and oil giant Chevron Corp., which typically allocate a portion of their profits in the hope of leveraging it in new-economy enterprises.
* “Angel investors,” wealthy folks who look to put a few million dollars into a start-up firm. Often the companies they fund are at a much earlier stage than what many venture firms seek; some are just ideas on a piece of paper.
This is an increasingly popular--and risky--area; rich investors are not always smart investors, veteran venture capitalists say.
How rich you have to be to be a venture capitalist, in any form, depends on your vantage point.
Randall Kaplan, a former executive at investment giant SunAmerica in Los Angeles, recently started JUMP, or Just Upwardly Mobile Professionals, a sort of upscale investment club. He said his investors range from billionaires to people with “under $1 million.”
“JUMP is not for rich people. Iit’s for those who work for an opportunity to invest,” said Kaplan, who noted JUMP has already made investments in 26 companies. “The best part is seeing someone go from unhappy and miserable at a big company to happy and fulfilled” as they get the capital to start their own company.
The 31-year-old Kaplan was one of four co-founders of Akamai Technologies, a Cambridge, Mass.-based Internet content delivery firm. He helped write the original business plan for the company as vice president of business development after he left SunAmerica.
Now he receives about 75 business plans a week from entrepreneurs and has hundreds of them stacked throughout his apartment. “I don’t want any more coming to the house,” he said, so he has just opened an office in Brentwood.
Kaplan’s decision to leave the corporate world of SunAmerica for venture investing’s green fields is becoming a more common occurrence. “There’s a fundamental shift occurring,” he said. “We are the new stars in town.”
Investment bankers, long considered the masters of the Wall Street universe for their work with corporate giants, are increasingly joining venture firms to fund much smaller businesses.
Defectors include those at the peaks of their careers, such as Rex Golding, the former head of technology investment banking at Morgan Stanley Dean Witter in Menlo Park, Calif., who left for Softbank Venture Capital, one of the funds controlled by Japanese conglomerate Softbank.
Another Morgan Stanley banker, Mark Menell, recently left to join TMCT Ventures, a $550-million fund in Los Angeles formed by the Chandler family and Times Mirror Co., which publishes the Los Angeles Times.
Wall Street stock analysts are also joining smaller venture shops, enticed by the chance for far larger payoffs.
“I wouldn’t say they are the heroes of this market, but venture capitalists are the people making the most money now,” said Keith Benjamin, who recently left his job as an Internet stock analyst at investment bank BancBoston Robertson Stephens in San Francisco.
He joined Highland Partners, opening that Boston-based venture firm’s West Coast office, which is in the process of investing $500 million.
Benjamin also saw the venture job as an opportunity to have a more flexible work schedule. As an analyst, he had started his day at 4:30 a.m. and ended it at 7 p.m., and he flew 140,000 miles a year.
Now, with a new baby in the house, “there’s more quality than quantity to my work. My days are more manageable, and I haven’t been on an airplane so far this year,” said Benjamin, 40.
Not surprisingly, the general public also wants in on the venture boom--and is getting the chance.
Funds such as MeVC.com, started by venture firm Draper Fisher Jurvetson, are targeting the upper middle class. Investors in MeVC must have a minimum of $50,000 in net assets and pull in $50,000 a year.
MeVC, which is still seeking approval from the Securities and Exchange Commission, would be listed on a national stock exchange and trade like a mutual fund when it launches. The minimum investment would be $2,000.
Average investors can already become VCs--of sorts--by buying shares of publicly traded venture firms, also known as incubators, such as CMGI Inc. of Andover, Mass., whose stock leaped tenfold last year, and Internet Capital Group of Wayne, Pa., which zoomed 28-fold.
A public offering expected early this year by Idealab, the prominent Internet incubator in Pasadena, will provide another vehicle.
On a broader scale, some analysts argue that many small investors have become venture capitalists without necessarily knowing it--by buying shares of the fledgling technology firms professional venture capitalists have been selling.
So far this year, 115 companies have gone public, raising $19.4 billion. Those new stocks have gained an average of 74% from their public offering prices, according to Thomson Financial Securities Data in New Jersey.
That gain, of course, is the payoff for the venture capitalists who were first to fund the companies.
But as the ranks of venture-funded firms soar, some veteran financiers warn of the day when the public, perhaps burned too many times by young companies destined to fail, refuses to throw any more dollars at new stocks.
That could leave the new crop of venture investors holding portfolios of struggling companies that have used up the capital they received and have little prospect of generating a return for their investors.
“We’re clearly seeing a frenzy. There’s no way all these companies can go public, and there aren’t enough sugar daddies in the world to buy all these companies,” argued Los Angeles venture capitalist Ravin Agrawal. “It’s suicide,” he said of the current venture boom.
For now, however, there are few signs that the boom is cresting. With billions of dollars of venture capital looking for ideas, entrepreneurs’ chances of finding the money they need may be better than at any time in U.S. history.
“The whole thing with venture capital is, keep the deal flow coming, just like Hollywood studios need scripts,” said Monica Dodi, founder of Web site Entertainment Asylum and now the entrepreneur-in-residence with Softbank in Los Angeles. “They are all looking for the big hits, and they need to keep those scripts coming.”
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Venture Investments Soar
During the 1990s, venture capital investments rose dramatically nationwide and in California. Investments, in billions of dollars:
*
1999:
$50.7 billion in U.S.
$22.2 billion in California
*
Source: Venture Economics
