The Smart VC at Highland
By Lawrence Aragon
Redherring.com
January 12, 2000
Keith Benjamin reaches into his wallet and pulls out two laminated photos of his son, "Little Bruce." Like the blonde-haired boy in the pictures, Mr. Benjamin is beaming. And, like 13-month-old Little Bruce, he's entered a whole new world -- venture capital.
An analyst for 17 years, the past 7 at Robertson Stephens, Mr. Benjamin joined Highland Capital Partners in October. While he's new to VC, Mr. Benjamin has studied more companies, markets, and business models than many of his peers. At Robertson Stephens, he tracked Internet stocks. Who better to bring a fresh perspective on Net investments?
Mr. Benjamin sat down for a Q&A with me in Redherring.com's offices. He turned his back on the ninth-floor view of San Francisco and gave me his full attention. He's a fast talker and often emphasizes words for effect.
VALUATION CONVERSATION
Q. How will the recent decline in tech stocks affect valuations of Net startups?
A. In the last week it has had absolutely no impact. As an analyst, I've seen a remarkably consistent quarter-to-quarter volatility in public market valuations but a remarkable lack of volatility in private market valuations. Would I expect a 20 percent decline in Internet or technology stock averages to have much of an impact on the private side? Absolutely not. Even if it actually turned out to be closer to a 50 percent decline, I think there would be an expectation that it just means we're braced for the next IPO cycle.
Q. You're honestly saying that if there was a 50 percent drop across the board in Internet stocks that you don't think that would affect valuations?
A. I think it might affect them a little bit, but it's not going to affect them 20 to 50 percent.
Q. Why is that?
A. Supply and demand. When I look at the public markets, I don't think we've quite tested the supply/demand equation. We have a lot of companies that have gone public, but we seem to have an increasing institutional and, maybe more important, individual appetite for Internet stocks across the board. When we look at the private markets, we've had an unprecedented influx of capital, so we have a tremendous demand that is creating more competitive situations. There is just too much competition among venture firms to see that much of a drop in the better deals.
Q. Well, I guess my question about whether VCs will try to use the decline in stock prices to push down valuations is moot.
A. I think it's more accurate to say that we could use a decline to help keep prices where they are. We're still dealing with a huge gap between private market valuations and public market valuations. And we're also dealing with a situation where it's impossible to pinpoint and rationalize valuations on either side.
Q. Red Herring editor in chief Tony Perkins coauthored a book called The Internet Bubble. Do you think the bubble will burst, and what will that do to valuations in general?
A. Let's define "bubble," because I don't believe what we're seeing should be characterized as a bubble. I apologize that I haven't read Tony's book. But I'm in such stark and fundamental disagreement with that as a way to approach the subject. Let me step back. Let's define what we all agree on, and if you disagree I'd love to banter back and forth a little bit. A bubble is a valuation increase where at some time we end up with no valuation. It goes pop and there's nothing there. Bubbles have occurred in two ways -- first, in ways like tulip bulbs, which everyone likes to point to, where we have supply/demand imbalance bubbles. The more significant and painful bubbles have occurred in areas like biotech, where, in the end, the drug didn't work. There was a bubble and, pop, at the end you had one out of a hundred businesses generate revenues. You then had price-related bubbles (oil) that were partially supply/demand created. Those are bubbles. I would not suggest that what we're seeing in Internet stocks is a bubble. I might agree that there are areas where there is supply/demand imbalance, but it's not a bubble. It's closer to electricity. When electricity was formed, people used it in a lot of different ways. It spawned a whole new set of businesses, where the initial valuation of companies delivering electricity might have been volatile. There were clearly failed utilities, but that didn't mean electricity was a bad business. In the end you had a valuable new platform.
WEB WAGERING
Q. What's Highland's Internet strategy? Where are you placing your bets and why?
A. Generally, it's opportunistic. A few themes have evolved that continue to evolve, although I will tell you honestly that there isn't a master plan. In the consumer space, the underlying theme has been viral. Maybe the better way to phrase it is "viral hybrids." The ultimate in viral is Hotmail [now owned by Microsoft (Nasdaq: MSFT)]. Did Hotmail ever spend any money on marketing? We like situations where you can take some word-of-mouth marketing and then we can invest money from Highland in order to jumpstart and accelerate that. The most recent example is Mercata. The other theme in the consumer space is viral content, like Beliefnet. Typically, people don't tell friends about content sites. There are some exceptions, and we think companies like Beliefnet are going to fall into that tell-a-friend category. It aggregates spiritual content, where other religious sites focus on one particular religion. The third investment theme is commerce in context that was viral. One of my favorite companies historically has been Babycenter [now owned eToys (Nasdaq: ETYS)]. Your wife and my wife told every pregnant woman they saw when that thing came out. The sneaky part is that the nature of the content lends itself to enabling purchases. TheMan.com is trying to provide commerce in context for men. It was one of my first investments. These feel like relatively long-lasting themes for consumer markets.
Q. What about business-to-business [B2B]?
A. For B2B markets, we're looking for save-your-job companies, or what I like to call "painkillers." What worries me about a company like Chemdex (Nasdaq: CMDX) [which Mr. Benjamin owns stock in] is that the problem they're trying to solve is not enough of a pain to their customers. If I'm a scientist spending $100 on a reagent, is it that inconvenient to get it from a catalog? We're looking for opportunities where it's either bigger purchases or more painful. In the B2B space, my thesis is that there are going to be very few markets that ramp quickly enough to meet the ridiculously high expectations. We have been very focused on the customer service market. Ask Jeeves (Nasdaq: ASKJ) has been one of our most successful investments. Say you have a B2B Web site online. One of the biggest pains is dealing with customer complaints and questions. Ask Jeeves outsources it for you and relieves the pain. Going forward you will see from us investments in emerging exchanges. We're looking for companies in vertical industries that are creating exchanges for big-ticket items and where we have identified some companies that are really painkillers.
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SNAPSHOT
COMPANY: Highland Capital
HEADQUARTERS: Boston
FOCUS: Internet infrastructure/commerce
INVESTMENT CRITERIA: 90 percent management team, 5 percent market opportunity, 5 percent "fit"
LAST FUND: $250M
NEW FUND: Approx. $500M (in the works)
NEW 1999 FUNDINGS: 22
1999 IPOs: 8
SAMPLE PORTFOLIO COS.: eToys, Ask Jeeves, Staples.com, Chemconnect, Wit Capital
REVIEWS UNSOLICITED BUS. PLANS?: Rarely; almost all deals are referred
UNIQUE ATTRIBUTE: Regularly invests in startups in distant locales
QUOTE: "I don't want to back an entrepreneur who I wouldn't want to work for." -- Keith Benjamin
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