Venture
capitalists step
up their pace
BY SHAWN NEIDORF
Mercury News Staff Writer
Almost two years ago, Warren Packard and his
colleagues at Draper Fisher Jurvetson knew they
wanted to invest just hours after hearing a
presentation by the co-founders of Direct Hit
Technologies Inc.
Packard was afraid of losing the deal, so he chased
down Direct Hit co-founder Mike Cassidy the same
afternoon, as Cassidy hiked the foothills behind
Stanford University. Taking the wrong trail and
unable to find Cassidy, Packard waited near
Cassidy's rental car until he returned. When Cassidy
showed up, Packard pulled out a term sheet that he
had typed in bits and pieces all day between
meetings, and presented it to Cassidy in the parking
lot.
``That was our record,' said Steve Jurvetson,
managing director of Draper Fisher Jurvetson
Managing Director.
The hustle paid off: this January, Emeryville's Ask
Jeeves Inc. announced it plans to buy Wellesley,
Mass.-based Direct Hit for about $500 million in
stock.
Draper Fisher Jurvetson invested almost $3.75
million in Direct Hit over three rounds of financing
and will get about $105 million from the sale -- a
28-to-1 return in less than two years, said Packard.
It's the potential for quick, sizable payouts like
Direct Hit -- and the fear of losing out on such
opportunities -- that has forced venture capitalists to
dramatically step up their pace, stimulating an
outpouring of venture capital unlike anything ever
seen before in the Bay Area.
In the fourth quarter, 362 Bay Area companies
received $5.7 billion, or almost five times more than
in the fourth quarter of 1998, according to the latest
Money Tree report compiled by consulting firm
PricewaterhouseCoopers and the Mercury News.
This flood of venture capital also has created an
investment cycle that seems to nourish itself: The
large returns allows VCs to raise big investment
funds, which then can be used to seed more
companies and create a hyper-competitive
marketplace where companies need still more
venture capital. This cycle is driving the VCs to
invest and the companies to grow faster and faster.
And what's driving the cycle itself? Theories point to
entrepreneurs' demand for venture money, the fast
pace of technological innovation, the easy IPO
market and public appetite for technology stocks
after the IPO, or a combination of all these.
Jim Breyer of Accel Partners knows the quickened
and expanded cycle well. In the past seven years, the
funds that his firm raised to invest in Internet
companies have grown progressively larger. In
1993, he started with a $135 million fund, which
lasted three years. Since then, Accel raised four
funds, including one of $600 million last year. And
he expects the firm to raise a larger pool of money
later this year.
High returns have allowed Accel to return to its
investors time and time again, asking for more
money. Last year, 11 of the organization's portfolio
companies went public, yielding a $5.6 billion return
on Accel's investment of $56 million -- a 100-to-1
return.
Keeping the investment cycle turning, Accel wrote
$372 million in checks last year and added 45 new
companies to its roster, both figures about double
Accel's 1998 activity.
That kind of pace, that kind of roaring, cyclical rush,
looks like the financial equivalent of a perpetual
motion machine, an invention capable of producing
more energy than it consumes, allowing it to run
endlessly.
``It's a perpetual motion machine which is
accelerating daily,' Breyer said. ``The venture
business and Silicon Valley entrepreneurship have
always been incredibly intense businesses that move
at the speed of light. What's happened over the past
year or two is that the pace, the frenetic activity and
the intensity have increased -- literally -- an order of
magnitude.'
Though venture capital investing might appear to be
a perpetual motion machine, continuously funding
itself through its own successes, increasing its
breadth with each turn of the cycle, it is not.
In the physical world, perpetual motion cannot work
because it violates the laws of thermodynamics
governing the conversion of energy to motion. The
concept of an endless, self-perpetuating cycle doesn't
work in the financial realm, either. The venture
investment cycle depends on an outside energy
source. What that energy is, however, is a matter of
contention.
Josh Lerner, professor of business administration at
Harvard Business School, said that over the long run,
the most significant driving force behind venture
investing is entrepreneurial demand. In other words,
VCs raise investment pools in response to
entrepreneurs' desire for funding.
And, pointing to factors that raised entrepreneurs'
desire for funding, Lerner said the increasing pace of
innovation has helped boost the demand for venture
investment. In addition, capital gains tax cuts have
made entrepreneurial companies that provide stock
options more attractive workplaces, he said.
Accel's Breyer disagrees. He thinks the public stock
market is the key stimulant to venture capital. If the
stock market welcomes new Internet companies at
their initial public offerings -- and continues to favor
them afterward -- the venture investing pace ``will
continue to accelerate,' Breyer said. ``The key link
in the food chain is, very simply, public market
valuations of Internet companies.'
Kirk Walden, national director of venture capital
research for consulting firm
PricewaterhouseCoopers, points to technology as the
energy behind the venture boom. ``If you believe that
(information technology) is responsible for one-half
of 1 percent of the productivity increases -- which is
what I've been hearing kicked around now, those are
huge numbers, and that's an opportunity so large you
can't get enough trucks through,' he said. ``That's
what all these entrepreneurs have been driving their
sports cars through.'
Internet companies increase their value on their
intellectual property, not their physical property, and
grow much more rapidly than companies in other,
more traditional industries, Walden said.
Whatever is really sustaining this venture capital
boom, VCs don't expect it to last forever -- or to stop
tomorrow, either.
``There is no one who can `crystal ball' how and
when the pace slows. There is simply no question
that this is not sustainable over the long term,'
Breyer said. ``Cycles do happen, and, inevitably,
there will be a negative cycle that hits Silicon Valley
and entrepreneurship. In the near term, however, I
see no signs of business velocity slowing down.'
``New company formation is occurring faster in
Silicon Valley than at any time in its history,' Breyer
added. ``If anything, as we enter the year 2000, it's
accelerating rather than decelerating.'
DFJ's Jurvetson sees the pattern, too, but he doesn't
like the perpetual motion-VC analogy, bothered by
the connotations of fraud that can taint perpetual
motion schemes. He does, however, see a ``success
spiral,' a ``snowball effect' in venture capital.
And the more visible successes there are, ```the more
entrepreneurs on the fence there are who say,
`Shucks, I'm going to do it. So-and-so was
successful, and I know I can do it better than he
did.' ' |
