[ VC continued ]
Valentine rose to prominence as a
marketing strategist at Fairchild
Semiconductor and then worked at
National Semiconductor. He began
investing small amounts of his own
money in the aspirations of some of the
customers who bought chips, local
techies for the most part, young wizards
fresh out of engineering departments.
"I watched how those young businesses
ran or were unable to run, and I thought
about why some of them succeeded,"
Valentine says. "To this day, my
education as a venture capitalist comes
from close observation of what happens
to the management teams we fund, from
these highly disciplined yet disobedient
visionaries."
As young scientists began pouring out of
Stanford and Berkeley (and the
universities clustered in Boston, the other
capital of technology venture capitalism),
Valentine set up Sequoia as a kind of
boot camp for a variety of young
geniuses forming a new California
subculture of technologist-entrepreneurs.
A young ex-Apple Computer whiz named
Trip Hawkins was given an office inside
Sequoia for months while he wrote a
business plan tha tdescribed the
pioneering computer-game company
Electronic Arts. Hawkins--who recently
founded the high-profile video
game-machine venture called 3DO--went
on to make tens of millions of dollars
when Electronic Arts went public in
1989, and Valentine reaped 20-fold
returns for his investors' early $1 million
stake.
"Don Valentine is one of the most
influential people in my life, "Hawkins
says now. "He helped me grow up as a
businessman. If you can't survive the
hazing Don puts you through, then you
certainly can't survive the crap that
comes your way as a company CEO.
Even now, I wear Don Valentine in my
brain. Sometimes I sense that a new idea
must be crushed and people must be sent
away to get their shit together--so I
simply turn into Don.
"At the beginning it isn't easy," Hawkins
says. "When I waswriting the Electronic
Arts business plan at 3000 Sand Hill,
Don took me to his golf club for lunch.
'If I wanted to run your company,' he
said to me, 'why in the world would I
need you?' He basically announced, We
are about to start a relationship in which I
will savagely beat you. If you roll over,
Don teaches, you won't be successful.
He's kind of like the professor in the
movie The Paper Chase. But it's hard.
Entrepreneurs come from optimism. Don
does not come from optimism. He's the
yang to the entrepreneur's yin."
Valentine is known for listening quietly to
highly produced sound and light shows
illustrating the glorious future of a new
start-up. At the end of the presentations,
he will often look at the young
entrepreneur and impassively say, "Who
cares?"
"I happen to thrive on the precision of
Don's language," says David O'Brien,
speaking in early October on the day
after lantec, the chip company of which
he serves as CEO, went public on the
Nasdaq market. "Don is the chairman of
our board, and while I know his style
intimidates some people, there is never
any fuzzy thinking. He has a model in his
head for a good company in each of a
dozen technology markets, and his goal is
to get his companies to fit the model. If
he's tough on entrepreneurs, don't forge
tthis is Silicon Valley and there are a lot
of techies out here with brilliant ideas
that don't include a clue about running a
company."
Many of the pros within the venture pack
have been entrepreneurs and company
operators themselves, and all of them
have extensive contacts and access to
resources.
Sequoia Partners considers commercial
propositions from 2,000 entrepreneurs
each year, and from that group perhaps a
dozen dreamers are invited inside to be
funded and connected to experts and
advised. In the process Don Valentine
and his partners seek to discern or create
the toughness required to build an
enterprise. The partners will help a young
company develop basic strategy, find key
managers, and help forge strategic
alliances. Many of the pros within the
venture pack have been entrepreneurs
and company operators themselves, and
all of them have extensivecontacts and
access to resources. So much legwork is
involved in the launching of a young
technology business that each of
Sequoia's eight partners handles no more
than four or five companies at a time. In
exchange for the connections, cash,
counsel, and instant credibility, Sequoia
and the other firms will often attain 10 to
25 percent of the company (in privately
held shares), along with a seat on the
board of directors. Valentine sits on five
different boards, is the vice-chairman of
Cisco Systems, and is the honorific,
nonoperating chairman of the boards of
C-Cube Microsystems, Network
Appliance, and lantec.
VCs assess a business plan in terms of
risk: market risk,
technology-development risk, and
management risk. "But in truth, the
evaluation isn't particularly scientific,"
Valentine says. "There's nothing
scientific about investing in science. It's
intuitive. We make a judgmentabout
when we think the science is going to
really happen, and we intuitively make a
judgment about what we're willing to
pay."
For the two or three days after a business
plan is judged worthy of investment,
Valentine and his people bicker with an
entrepreneur about the current value of
future dreams. "That's the only time we
want to be adversaries," Valentine says.
The entrepreneur is usually presented
with a "term sheet" and illustrations that
show the radically enhanced value of the
founder's hundreds and thousands of
freshly minted shares as the company
moves through subsequent fundings
toward the public marketplace. If some
company-creators do turn their heads to
the right side of the spreadsheet and the
millions of dollars' worth of equity that
might come with success--this, despite
the fact that capitalists, who have
participated in the subsequent rounds of
financing a fast-growing business
requires, might by then own 60 to 90
percent of the company--then most of
them focus on the cash needed to make
their business grow. Certainly the ones
worth betting on do.
Once the money is in hand, many
entrepreneurs find that the involvement
of a seasoned VC pro can be intimidating
as well as helpful. Valentine's corporate
children talk of the monthly specter of
their own financial reports coming back
with telltale markings from Valentine's
famous green pen.
Trip Hawkins once looked at an early
Electronic Arts financial statement on
which the operating loss for the month
and the borrowing power and cash left
on hand were all circled in green. "TWO
MONTHS LEFT" was scrawled across
the bottom of the document. "But by
then, Don had instilled a toughness and a
sense of resolve that helped us solve our
operating problems and succeed,"
Hawkins says.
VCs--or "vulture capitalists" as
spurned entrepreneurs like to call
them--sometimes rush IPOs and sales
of companies as a result of their
greed, say critics of the industry.
When venture capitalists lose faith in an
entrepreneur's ability to solve his or her
own problems, they will often move in t
ochange a management team or even
force the sale of a company. Venture
firms draw their capital from sources that
must reap rewards within seven to ten
years, the preordained life span of the
typical venture fund. The timetable leads
critics of the industry and disaffected
entrepreneurs to contend that some
rushed IPOs and sales of companies--and
tossed-out managements--are often the
result of VC greed or inappropriate
expediencies. To spurned entrepreneurs,
VCs can be "vulture capitalists," financial
predators who hide behind a rhetorical
wall of altruism and camaraderie. Even
amid wealth and success, entrepreneurs
will characterize their VCs as necessary
evils. "They are so glamorous and
beautiful at first and deadly like
Catherine Deneuve in The Hunger," says
one software entrepreneur.
In 1976, only a year after Don Valentine
funded the young computer scientists
behind Atari, arguably the first
high-technology company to connect the
American obsession with new modes of
entertainment to the computer--and
certainly a pioneer of what has become a
$6 billion computer and video-game
industry--he pushed the Atari founders
into selling out to Warner
Communications. The sale of Atari
brought $28 million, $15 million of which
went to founder Nolan Bushnell.
Valentine quadrupled his grub stake in
the process. Atari was able to gallop from
$50 million in sales to $2 billionin just
five years. But the company quickly
followed an Icarianpath to extreme
success and failure; Atari has virtually
disappeared. "And that's all people
remember," Valentine growls. "Atari was
one of the great Silicon Valley
companies. They only remember that
after the sale it fell apart."
A typical Sand Hill Road venture fund
might include $100 million or $300
million that the partners apportion to a
portfolio of young companies. The
venture funds are usually designed to be
liquefied after seven or ten years, though
most partnerships distribute realized
profits as takeovers and IPOs occur.
One of the interesting ironies of the
venture-capital world is that despite the
intimacy and hands-on involvement of
the VCs, the pros are almost never
playing with a lot of their own money.
The investment funds hail almost
exclusively from the coffers of pension
funds and other tax-exempt entities,
which invest via a legal provision that
allows nonprofits to apportion 5 percent
of their portfolios to "alternative"
investments.
"These are extremely illiquid assets,"
Valentine says. "Rich people would love
to invest with us, but rich people die and
get divorced. Then liquidity becomes an
issue. And with a divorce, I might have
some nightmare wife's lawyer on my
back trying to force something to
happen. Forget it. It's not worth it.
Tax-exempt money is a simple solution
to a potential problem."
Which is not to say that a tremendous
level of personal reward doesn't ride on
the long-range bets of individual VCs.
The way a venture partnership splits up
the take is a subject of much secrecy and
conjecture, but most partners admit that
the "carry," or carried interest, that the
partnership gleans from profits, comes in
at around 20 to 25 percent of returns.
The payouts of companies that go public
are usually in stock, and in many cases
the shares continue to soar. The
partnership also collects management
fees of 2 to 3 percent of a fund's total
equity. In the case of some of the
recently accrued VC "megafunds," such
as the $600 million VC fund run by
Summit Partners in Boston, a small
number of partners are splitting many
millions of dollars just for coming to
work.
The down market for the VCs
continued until 1992. But by 1994 the
boom was on again, and new funds
were turning away money.
The wealth, paternal power, and glamour
accruing to high-profile VCs have created
a discernible new category of economic
superstar. In Menlo Park and San Jose,
citizens speak easily of founder's stock
and carried interest and deal flow. If yet
another gearhead is about to relocate
from a dorm room at Stanford to one of
thebiggest houses in Palo Alto, then local
chat will carry the news. They talk easily
about the comparative IRR (internal rate
of return) reaped by various venture
firms and trade tidbits about KP (the
powerhouse Sand Hill firm of Kleiner
Perkins Caufield& Byers). Local gossip
also includes news of VCs who--though
their levels of conspicuous consumption
pale before that of the entrepreneurs they
support--have been known to have their
fine cars flown to places they want to
visit. There is talk of $15 million yachts
and of a $16 million VC house built in
the image of a Loire chateau. "In many
ways it's like a little Amish community,"
notes the young Sequoia partner Michael
Moritz. "But the horse and buggy
happens to be a Mercedes 500SL."
A glance at the recent economic history
of Silicon Valley reveal sa fascinating
combination of capital, entrepreneurial
impatience ,and cutting-edge science.
Specialized technology law firms,
research think tanks, prototype
fabrication plants, and a public full of
"early adopter" citizens fit to test new
devices all grew up to join the technology
VCs and entrepreneurs. The universities
served up new human and technical
feeder stock by the academic quarter,
and young techies from other parts of the
country surged into town. Silicon Valley
quickly became a test tube for
entrepreneurial "creative destruction" as
young teams of techies constantly bailed
out of established companies to start their
own enterprises. At least ten new
companies were formed by alumni of
Hewlett-Packard alone between 1980
and 1982.
By 1982, just before the cynosure of
heroic capital switched back to Wall
Street and the buyout kings, LBO lords,
and other Masters of the Universe,
young students of money everywhere
wanted to grow up to be Valley-style
VCs. From the viewpoint of the
venture-pack pros, amateur money and
talent then flooded the field and drove up
the all-important cost of entering deals.
Though individual technology
entrepreneurs like Bill Gates achieved
unprecedented wealth during the
1980s--and Microsoft, Sun
Microsystems, Oracle, Adobe Systems,
Autodesk, and Novell all went public in
the same 12-month period in 1985 and
1986--the yearly returns of venture funds
dipped embarrassingly close to
single-digit levels.
"The really inept people came in as 'late
stage' or 'mezzanine' investors,"
Valentine says. "They bought into
companies between the early-stage
investments we do and the public
markets, but they didn't recognize that
late-stage venture investing means finding
companies with revenues and profits.
They weren't able to do the hands-on
stuff we do, and after a while they went
away."
The down market for the VCs continued
until 1992, though the pack sent more
than 150 new companies into the realm
of public-market investors each year. By
1994 the boom was on again, and new
fund swere turning away money.
"Rise of the Silicon Patriots" is continued
in the Part 2 file in this folder.
This article appeared in the
December/January 1996 issue of Worth
magazine.
Sorry about the format, but it's no worse than CAP Line Code. |
