Steve Lisson, Stephen N. Lisson, Stephen N. (Steve) Lisson
Behind the VC Music FORTUNE Valley Talk
How to rate a venture capital firm
TheStandard.com
Fallen VC Idols
By Gary Rivlin and Lark Park
They talk about it at their children's school plays. They ask the question
at Palo Alto power lunches: Who among them, the Silicon Valley
venture capitalists wonder, will be first to turn in a lousy return for their
funds?
It's a question no one asked in the boom times, but this is a very
different world for VCs. Venture investing in the first quarter of 2001
was down 59 percent from record highs. Dozens of venture-backed
dot-coms have gone out of business, and hundreds of others are still
years away from profits. Funds that invested rapidly at the peak of the
frenzy have seen the value of their investments fall 75 percent or more.
"There are some big-name funds out there in trouble, there's no question
about it," says Kathryn Gould, an 11-year industry veteran and a partner
at Foundation Capital, echoing a sentiment expressed by many VCs. "I
hear it from our limited partners, who are invested in a lot of the big
funds."
The limited partners - wealthy individuals, pension funds and college
endowments that invest in venture funds for double-digit returns - are
bracing for single-digit returns this year, well below the triple-digit
returns seen in 1999 and even the average 27 percent return over the
past 10 years. In the worst-performing funds, the limited partners could
face losing the capital they originally invested.
It's no surprise that plenty of also-ran venture shops and incubators that
popped up during the bull market are struggling with soured
investments. Many limited partners sought out the top VC firms
precisely to avoid such a risk. But some of those top firms - the ones
that supposedly had the wisdom and experience to know better - made
what now look like serious missteps at the height of the bubble. They
often focused on dot-coms with little hope for profitability. Worse, they
invested so quickly that they had little left over to nurture startups
through the downturn that followed. Now Draper Fisher Jurvetson,
Hummer Winblad, Redpoint Ventures, Softbank Venture Capital - even
the undisputed superstar of the venture world in the second half of the
1990s, Benchmark Capital - are sitting on at least one problem fund.
REPERCUSSIONS OF THINGS PAST Several leading VC firms
raised funds during the peak of the Internet bubble. But five -
Benchmark Capital, Draper Fisher Jurvetson, Hummer Winblad,
Redpoint Ventures and Softbank Capital Partners - were aggressive
in investing much of their funds early in now-struggling dot-com
startups. FIRM FUND YEAR RAISED AMOUNT (IN MILIONS)
% OF FUND IN- VESTED % OF MONEY RETURNED TO
INVESTORS % OF COMPANIES FUNDED AFTER APRIL 2000
**** DIVERS- IFICATION FACTOR Benchmark Capital
Benchmark III 1998 $149 100%** 0%** 53% Poor Draper Fisher
Jurvetson DFJ V 1998 $180 80%** 24%** 44% Moderate Hummer
Winblad Hummer Winblad IV 1999 $315 75%*** N/A 48% Poor New
Enterprise Associates NEA IX 1999 $871 65.1%* 0%* 68% Good
Redpoint Ventures Redpoint I 1999 $600 60%* 0%* 66% Moderate
Softbank Venture Capital Softbank V 1999 $600 100%** 0.01%**
50% Poor US Venture Partners USVP VI 1999 $278 84.3%* 0% 55%
Good *As of Sept. 30. **As of Dec. 31. ***Estimate. **** Excludes
companies that have gone public or been acquired. Sources: InsiderVC,
Venture Economics and Venture One
Of course, many venture funds are still so young that a couple of big hits
could cover a long list of bad bets. In the image-obsessed world of VCs,
however, even one down year is the kind of thing that could tarnish a
firm's reputation.
"The way venture capital works, or at least used to work, was you
invested in a fund over two or three years so you captured several years'
worth of trends," says one longtime venture capitalist who, like most
VCs and limited partners interviewed for this story, would only speak
anonymously. "But in '99, you saw some well-known VCs go through
their whole wad in a six- to nine-month time frame, so they only
captured a partial year of trends. Those are the funds the limiteds are
worried about."
Eighteen months ago, a venture fund reporting a negative return was
unthinkable. The Nasdaq was climbing toward 5000. Tech IPOs were
tumbling out the door, with investment bank analysts minting new
metrics to justify the skyrocketing stock prices. So venture capitalists
blithely laid down tens of billions of dollars on dot-coms. The biggest
risk VCs faced seemed to be missing out on the next eBay.
"If a deal was hot enough, you locked the door and didn't let the
founders out until they had at least verbally committed to a deal," says
Neil Weintraut of 21st Century Internet Venture Partners. "We realized
only once it was too late that we forgot to pay attention to this one
important factor called profitability." It's a confession akin to a pro-ball
scout proclaiming a player has all the intangibles to become a starter in
the NBA - except he can't shoot.
VC money legitimized the dot-coms, and stock investors legitimized the
investments with inflated valuations. The highest-profile VCs got drunk
on their own celebrity and personal wealth. At the peak, stars such as
Redpoint Ventures' Geoff Yang were wondering aloud whether there
was any downside left in the game. "If the company doesn't work out,
we'll sell for $150 million," Yang told Fortune in 1999. "If it does, it'll
be $2 billion to $10 billion. Tell me how that's risk."
Yang got his answer when stocks crashed in 2000. Now the wider world
no longer buys the story that dot-coms will rule the world; those flying
the highest during the boom times are today's goats. The technology
world's best-known investment bankers operate under a cloud of
scandal as federal investigators question the legality of their IPO
allotment practices. The Internet's best-known research analysts are
reeling from charges they touted highly speculative stocks more out of
self-interest than in a belief in companies whose shares are now trading
90 percent or more off their highs. And the venture capitalists, once
lionized for their ability to spot huge hits, are getting their comeuppance.
Last week, for instance, Webvan, the ultimate VC poster child last week
was worth $77 million, down from a market capitalization of $2.5 billion
only nine months ago.
Venture capital firms hold information about their funds' performance
close to their chests - especially the current valuation of their
investments. Even so, there are plenty of clues that point to a fund in
trouble: How close is it to prematurely spending all the money it raised?
How many of its companies have been able to raise money since the
stock market crashed? How much of the fund did the firm plunk in the
dot-com pot? How many startups have gone out of business in the fund's
short life? And how much money are limited partners getting back on
their investments?
FIRM DESCRIPTION COMPANIES IN FUND INCLUDE ...
Draper Fisher Jurvetson Led by Tim Draper, DFJ charged into the
online retailing and b-to-b sectors in its fifth and sixth funds. More than
half the companies in the fifth fund have yet to raise new funding in a
tough market. BestOffer.com, DigitalWork, Everdream,
InfoRocket.com, SeeUThere.com Hummer Winblad John Hummer and
Ann Winblad have never produced a home-run investment. It is unlikely
that its fourth fund, the first to focus on the Internet, will improve the
firm's track record. Homes.com, Lavastorm, Mambo.com, Pagoo.com,
Rivals.com Redpoint Ventures Geoff Yang and his five partners
invested in 40 startups in 14 months. Their silver lining: More
investments in infrastructure firms than in dot-coms. BigBand
Networks, eNet China, HelloBrain, MetaTV, TeraOptic Networks
Benchmark Capital The firm's third fund, raised in 1998, was alm! ost
exclusively invested in dot-coms. David Beirne and Benchmark partners
opted to spend most of the fund's capital in nine months. Collab.net,
Epinions.com, Guild.com, Living.com, Respond.com Softbank Capital
Partners Gary Rieschel admits his fund was overweighted in sectors
that "got smashed." He's already telling investors the best they can
expect are money-market-like returns. Asia Online, BlueLight.com,
iChristian.com, Rentals.com, Secure Commerce Services
Steve Lisson devotes his time to such questions. He is at once an
industry gadfly and a font of information on venture funds; his Web site,
InsiderVC.com, is followed closely by many in the business. With the
help of Lisson and research firm Venture Economics, The Standard has
assembled profiles of major VC funds raised in 1998 and 1999. Because
dozens of funds opened during the peak of the tech bubble, we limited
our list to several high-profile firms.
While any fund raised during the last few years is enduring tough times
now, not every one is in the same boat. Funds raised by Battery
Ventures, Kleiner Perkins Caufield & Byers, New Enterprise
Associates, Sequoia Capital and US Venture Partners have their share of
ailing dot-com investments. But they diversified into areas like biotech,
networking and software for big companies. Also, they didn't spend their
money as quickly as Benchmark and Draper did with their vintage 1998
funds, or as Hummer Winblad, Redpoint and Softbank did with their
1999 funds. The latter are the ones slowly coming into focus as strong
candidates for subpar performance.
Any recitation of the funds in greatest jeopardy should start with
Hummer Winblad and Draper Fisher Jurvetson. Ann Winblad and Tim
Draper, the public faces of their respective firms, are better known for
being well-known than for their skill at spotting promising startups.
Winblad is a columnist for Forbes ASAP, and Draper is an investor in
Upside and a long-time friend of Tony Perkins, who founded both
Upside and Red Herring magazines. Yet both firms have suddenly
turned press-shy. Representatives of the two firms declined to comment
for this article.
After mixed success in three funds that focused on software companies,
Hummer Winblad raised $315 million for its fourth fund, which it
invested almost entirely in Internet ventures. "It's like the entire
portfolio was made up of dot-com, swing-for-the-fences deals," says a
limited partner for one of its funds, who asked not to be named.
So dismal are the prospects for Hummer's fourth fund - among its were a
laundry list of dot-bombs including Gazoontite, HomeGrocer, Pets.com
and Rivals.com - that general partner John Hummer recently felt
compelled to send a letter to its limited partners. "It is an
understatement to say how bad we feel about this," he wrote.
For his part, Draper took a scattershot approach that not only backfired
when the dot-com sector collapsed, but also made the firm look
careless. "I don't even count Draper as a real venture fund," says an
institutional investor who has money in roughly 50 venture funds.
"They're like this index fund that indiscriminately invested in
everything."
Both Draper V, a $180 million fund, and Draper VI, which raised $375
million, are full of businesses with an online angle. Four companies in
Fund V are already out of business. Draper VI has its share of firms
from the Internet bubble, including Club Mom, a content site for
mothers; Amazing Media, a banner ad technology firm; and Product
Pop, an Internet-marketing services company.
Draper did hit it big recently. Cyras Systems, a fiber-optics firm in Fund
V, was acquired in March for $1.15 billion in Ciena stock. That's a
significant score - but it's questionable whether Draper's take will be
enough to balance out the other dogs in the fund.
Redpoint is a venture capital supergroup, with partners who defected
from Institutional Venture Partners and Brentwood Venture Capital. But
the firm's first fund, which raised $600 million, so far has been short on
successes.
The six partners at Redpoint took just 14 months to invest in 40 startups,
most of them Internet-related. There was an $8 million investment in
BizBuyer.com, a b-to-b company that closed shop last year, and $22
million in NexGenix, one of many companies created to build
e-commerce sites. Other investments include $3 million in an online
beauty site, $4 million in an e-commerce company called eNet China
and $6 million in a sci-fi Web site that shut down operations in April. A
year ago, NexGenix filed to go public - Redpoint's first chance to cash
out and distribute the proceeds to its limited partners - then pulled the
offering in May. Four months later, NexGenix laid off an unspecified
number of employees.
Redpoint's two saving graces were that it set aside about half its fund to
keep its startups going and that it invested outside the dot-com realm.
Yang figures roughly 70 percent of Redpoint's first fund is invested in
infrastructure and software firms, though many were e-commerce
companies that have shifted their focus hoping to stay alive. "At least
we don't have 70 percent of the fund in e-retailing," he says.
Fate has been a little less kind to Softbank Venture Capital. The $600
million Fund V invested in 48 startups in approximately 12 months,
including companies such as Buy.com, eCoverage, eOffering.com,
Perfect.com and Rentals.com. The portfolio also includes iChristian, an
online religious bookstore, More.com and Urban Media
Communications, all of which have gone out of business; BizBlast, a
company that hoped to help small businesses get on the Web but ended
up laying off more than half its staff last fall; and iPrint.com, which
went public just prior to the spring 2000 crash and traded last week at
less than 50 cents a share.
According to Lisson, Softbank V has already parceled out all of the
fund's money yet has distributed no money to investors. Softbank VCs
admit the fund overindulged in vulnerable sectors.
"We were overweighted in services, and when that sector got hit our
fund got smashed," says Gary Rieschel, executive managing director of
Softbank Venture Capital. "We were also overweighted in Internet
consumer and business-to-business, rather than core technologies."
Still, Rieschel pledges, "we'll have a few nice pops and even a couple of
home runs." He's already told the fund's limited partners they can expect
a return of 150 percent to 200 percent. That might sound like a good
payoff, but funds typically have a 10-year life span. Doing even the
more optimistic math means this comes to about 7 percent a year, which
is barely better than a regular money-market account, despite the
enormous risk inherent to venture investments during an economic
slowdown.
Perhaps the biggest disappointment comes from Benchmark, a firm
whose towering reputation gives it that much further to fall. The firm's
success with Ariba and eBay sealed its reputation as one of the most
successful VC firms of the late '90s. How, then, does it get lumped
together with Hummer and Draper when insiders mention troubled VC
funds?
Mainly because of the performance of Benchmark III, the firm's third
fund. The fund raised $149 million in the second half of 1998, and then
spent all that cash in nine months, a fraction of the three-year average
before 1998. In all its other funds, Benchmark has invested in 21
networking-equipment and semiconductor startups, 10 software
companies and another six firms in the wireless market - but fund III has
only one investment in any of these categories: Collabra, a software
company. The fund has three investments in networking services
companies.
According to Lisson's data on Benchmark III, the partners invested in
24 startups, including Epinions.com and Living.com. By last fall,
though, the fund was down to a portfolio of 18, half of which were in
online retailing, with another three in the business-to-business sector.
Four others have since gone out of business, including Great
Entertaining and CharitableWay.com, representing more than $20
million in losses. Of the remaining companies, five have struggled with
cutbacks and layoffs.
Benchmark partner Kevin Harvey denies that Benchmark III is
performing poorly: "I feel confident that fund three will perform at the
top of its class." He also says that Benchmark IV - raised in 1999 - is
already proving a success with two public offerings.
Benchmark had always defined itself strictly as an early-stage investor,
but when it invested $19 million in 1-800-Flowers, the partners rolled
the dice on a "mezzanine" investment - an investment in a company
poised to go public. That proved costly. 1-800-Flowers is the one
company in the fund that has gone public. But by September 30, 2000 it
had racked up a loss exceedig $10 million for the fund, according to
InsiderVC.com. After publication of this story, Benchmark said that loss
has fallen to $2 million.
Compounding its bad bets, Benchmark failed to hold back enough of its
reserves for further financing. VCs usually reserve about half of a fund's
cash to make later investments in its most promising companies. Within
the venture world, it's generally frowned upon to pull money out of a
new fund to salvage a company funded by a previous one. According to
its contract with limited partners, Benchmark is permitted to crosspollinate
between funds, but doing so, experienced VCs say, raises the
question of whether you're trying to cover for old mistakes with new
money.
In general, VCs try to avoid such cross-fund investments. "It's
something you should do very rarely and only when you have complete
confidence in a company," says Geoff Yang, a 16-year VC veteran.
"Otherwise, there are huge opportunities to get second-guessed by your
limited partners, who might think you're using one fund's money to prop
up the investment of another." On at least three occasions, Benchmark
has dipped into fund IV to invest in fund III companies, including a $3
million investment in the now-defunct Living.com.
Still, Benchmark remains confident in fund III's long-term performance.
Despite the carnage so far, the firm is convinced at least five of the
surviving companies could single-handedly provide a $1.5 billion return.
VCs by nature are an optimistic bunch, but the boys of Benchmark may
be an extreme example of the breed. The world around them has
changed dramatically, yet they still believe that a $1 million investment
in fund III will eventually return $150 million to investors.
That would take quite a turnaround. Until then, Benchmark, like other
VC firms with hangover funds, can try again with newer funds, for
which they've so far had little problems raising money. The question is,
will their reputations recover as easily?
Kathi Black, Diana Moore, Katie Motta and Jeff Palfini contributed to
this report.
CORRECTION:
An earlier version of this article should have stated that Benchmark
Capital's third venture fund has invested in a software company,
Collabra. Also, due to an editing error, the story should have stated that
Benchmark III has no investments in networking equipment, and that
the $10 million loss the fund faced on an investment in 1-800-Flowers
was as of Sept. 30, 2000.
Earlier stories from TheStandard.com:
Floyd Kvamme: The Emissary
Dado Banatao: The Adventure Capitalist
The Retreat of the VCs
Money Watch
Venture Buzz: Putting Its Billion to Work
Copyright © 2001 The Industry Standard. All rights reserved.
STEPHEN LISSON, STEPHAN LISSON, STEPHEN N. LISSON, STEVE LISSON, STEVEN
LISSON, STEVEN N. LISSON, INSIDER VC, INSIDERVC, INSIDERVC.COM
