Follow the Money
Top-Tier, Aspiring, and Expiring VCs
When you rummage through the IPO investment prospectuses of the hottest companies in technology, names like Kleiner, Perkins, Caufield and Byers, the Sequoia Capital, and Venrock Associates are often disclosed as the biggest investors in the deals. While venture-capital activity is largely a private affair, it's never been too hard to pick which firms were boasting the biggest returns for their investors. Put your ear to the ground near the foothills of Menlo Park, California, and you can hear a rumbling herd of VC leaders. The names of these "top-tier firms" have remained largely the same over the last dozen years or so. (See inset table.)
To the chagrin of "second- and third-tier firms," institutional investors who traditionally pump cash into VC funds, such as pension funds and universities, are beginning to wake up to this trend. Almost uniformly, they are pulling back and investing only in the top-tier group.
"When we were out raising our first US$20 million seed fund in early 1993, before anyone knew who we were, it was clear that the institutions, including the management companies that invest money for Stanford and Harvard universities, were not too interested in experimenting with new VC funds," recalls Tim Draper, general partner of Draper Associates, one of the few new VC funds to have recently gained top-tier status. Conversely, Mike Moritz, of first-tier player Sequoia Capital, confided that his firm declined to take $50 million of capital offered by its limited investors, because it was more than Sequoia wanted to manage.
Both gentlemen's experiences were recently confirmed by a private study on venture capital conducted by a major university that prefers anonymity. The study concluded that although the venture industry's average returns are edging down, the returns of top-tier firms are projected to remain high, further consolidating the business into the hands of a small fraternity.
So what's an aspiring VC looking for money to do? "We raised cash for our fund in smaller denominations. We also raised money from wealthy entrepreneurs who make faster investment decisions than the big institutions," Draper explains.
Of course, Draper comes from the kind of blue-blooded background that helps open many vault doors not accessible to the technology bourgeoisie. Draper Associates also made writing the check a little easier for its investors by offering them a deal that required only 50 percent of the promised investment up front.
Other wannabe VCs with fewer connections to wealth are trying to leverage the multimedia hype by putting new media spins on their investment pitches. One of the more interesting recent venture-fund offerings came from the Hollywood-based Fusion Fund, where four general partners intend to leverage their backgrounds in entertainment production and digital technology to help develop multimedia-content and enabling-technology companies. "We are betting that the Big Bang occurring in digital media and communications is creating huge new opportunities for media producers," says Fusion Fund general partner, Jeffrey Diamond. "So far, a lot of people are listening, so we remain optimistic."
While the wannabes in the bottom tiers may be hustling for cash, life in the top tiers isn't exactly bliss either. After a long run of significant returns, the partners at two Menlo Park-based venture firms, Merrill, Pickard, Anderson & Eyre and Technology Venture Investors (TVI), recently announced they are parting ways, and will not be raising any new funds together.
It's rumored that two of TVI's former partners, Dave Marquardt and John Johnston, are distancing themselves from their older partners and are exercising their own muscles by starting a new, yet-to-be named, venture fund that will exclusively invest in software start-ups. This shouldn't seem so shocking given their backgrounds. Marquardt is famous for landing the only VC investment in Microsoft, where he remains on the board of directors; John Johnston was one of the original investors in Sybase while still at Hambrecht & Quist Ventures. Another former TVI partner, Bob Kagle, is expected to team up with Merrill, Pickard's two young bucks, Bruce Dunlevie and Andy Rachleff - also to start their own fund. "It's a classic case of everyone scrambling to get out of each other's shadow," observes one venture capitalist who has co-invested with both TVI and Merrill, Pickard. Thus far, no rumors have surfaced regarding the future activities of any of the senior partners from TVI and Merrill, Pickard, but presumably they could take their venture winnings and live happily ever after.
Firms such as Kleiner, Perkins, Caufield and Byers have been able to avoid hostile breakups of their partnerships by carefully planning for transitions. "Every partner is treated exactly the same, and we have a well-defined track for new partners," says Kevin Compton, the company's newest general partner. Since it raised its first fund in 1972, the firm has gracefully retired name partners Eugene Kleiner, Tom Perkins, and Frank Caufield, and groomed VC superstars such as Compton, John Doerr, and Sun Microsystems founder Vinod Khosla.
Switching briefly to our monthly TWIT$ portfolio, I am pleased to report that our first month of activity (December) produced an average return of 11.5 percent. For January,
I will be mostly holding onto my entertainment software and online service stock picks, skimming profits from my networking plays, and selling my multimedia-enabling technology company stocks. To complement my short on 3DO, I will also be shorting Microsoft. As Maxis's CEO Jeff Braun recently told me, "Windows isn't a consumer operating system, it's a pain in the ass." Microsoft should not be able to get away with buggy and cumbersome software that is continually late, like Windows90-something.
The Wired Interactive Technology Fund (TWIT$)
Company Symbol Shares Price Jan 3 Since Dec. 1 Action ——————————————————————————– Interactivity Electronic Arts erts 3,200 19 1/16 - 1/8 hold Brøderbund brod 1,100 45 3/4 + 11 hold America Online amer 2,800 52 3/4 + 11 1/4 hold The 3DO Company thdo 3,000 9 3/4 - 3 hold short Multimedia Tools Silicon Graphics sgi 2,700 29 1/2 - 1/4 hold Alias Research adddf 3,300 17 15/16 - 5 5/16 sell Wavefront Technologies wave 5,200 12 + 1/2 hold C-Cube Systems cube 2,500 18 3/4 + 1/4 sell Mobile Computing Mobile Telecom mtel 3,300 19 + 2 5/8 hold Motorola mot 1,600 57 + 7/8 hold Compaq cpq 2,000 39 3/8 + 1 1/8 sell Interconnectivity 3COM coms 1,800 49 5/8 + 6 3/8 sell Cisco Systems csco 2,500 34 1/8 + 1 7/8 hold Alantec altc 5,200 29 5/8 + 9 5/8 sell New Stocks Microsoft msft 500 60 3/16 short Maxiam mxim 4,600 34 buy The Learning Company lrng 6,300 24 5/16 buy Spectrum Holobyte sbyt 11,700 13 3/8 buy Current Portfolio Value$1,115,698.75+11.57% We were a bit too cautious for our own good last month. We reserved a chunk of cash equal to the 3000 shares of 3DO we shorted, and to give ourselves an added cushion, we didn't spend the money we got from the initial deal. Well, we've proved ourselves and Louis trusts us with the checkbook, so from here on when we go short on a stock, we won't spend the money we get from shorting until we square the account, but we're not going to hold any extra in reserve.
Legend: This fund started with US$1 million on December 1. We are trading on a monthly basis, so profits and losses will be reflected monthly, and profits reinvested in the fund or new stocks.
Anthony B. Perkins (kids@netcom.com) is publisher and editor in chief of The Red Herring, a monthly investment magazine published in San Francisco.
