Venture capitalists endure staggering losses
BY MATT MARSHALL
Mercury News
The Silicon Valley Fastest 50 might have been fast, but they were slow to make money for their investors.
So slow, in fact, they went backward. Stocks of all but one plunged over the past 12 months -- a majority of them losing 80 percent of their value or more. Individual investors suffered huge losses -- more than they would have if they'd invested in the average Nasdaq company, down 69 percent.
For the first time ever, most venture capitalists lost big money, too. Venture capitalists invest early in a company's life, and traditionally have made the most money from a company as its value appreciates. These VCs invest when the company is tiny, and so can buy up a big stake of ownership at a low price. When they sell their company shares at a public offering, venture capitalists can make a killing.
But the money lost over the last year was the result of a new attitude. About three years ago, euphoria surrounding the Internet began changing the rules of investing. VCs and other investors began putting money in companies -- even in non-Internet companies -- that weren't even close to profits -- hoping to strike gold on the future of the so-called New Economy.
In hindsight, the New Economy was ephemeral, the old rules have returned with vengeance -- and VCs are now paying for their past sins.
Take the fastest-growing Silicon Valley company last year, Transmeta, the Santa Clara producer of the Crusoe chip. At first, the company looked like a gold mine for its venture backers. Its market value soared to $17 billion in November, representing a whopping 5,400 percent return on investment for its early investors.
Then its stock succumbed to the stock-market crash. The company's public value plunged to a mere $215 million late last week, or $1.60 a share from a high of more than $50.
Its stock price is now lower than what venture backers paid per share when they invested in Transmeta. At least eight of Transmeta's backers, including Sony, Compaq Computer, America Online and Vulcan Ventures -- the venture capital firm founded by Microsoft co-founder Paul Allen -- bought into Transmeta when they valued its shares at between $6 and $10. In just one example, America Online invested $17 million into the company, buying shares at $10 each. That translates into a $14.28 million loss, based on Transmeta's current value. Sony, Compaq and Vulcan have all lost millions, too.
Only the earliest venture capitalists -- the ones who made the very first investments in Transmeta -- made money. They include Silicon Valley venture firms Institutional Venture Partners and Walden International, which invested as early as 1995 at $1.65 a share.
IVP held the most lucrative position, scooping up the most shares at that low price: IVP's return was still valued at about four times the $16.7 million it invested -- a relatively good return by VC standards. Still, IVP's return is much less than the estimated 54 times IVP could have earned had it sold its Transmeta shares at its post-initial public offering highs in November.
William Tai, the partner at IVP who made the investment at Transmeta, said he held onto much of Transmeta's stock after its public offering -- even after the expiration of the six-month holding period required by the Securities and Exchange Commission rules -- because he believes in long-term support of his companies. ``I like to keep building,'' he says. Tai still sits on Transmeta's board.
Transmeta's story resembles that of most of the other Silicon Valley Fastest 50. Later venture capitalists got pounded as valuations fell, and only the earliest investors remained above water.
In part, venture capitalists are suffering because they disregarded some of the industry's time-honored practices.
Until about 1997, venture capitalists and investment banks waited for a company to log from two to four straight quarters of profit before taking it public. However, beginning in 1997, market euphoria about the Internet and the allure of quick profits pushed VCs to take their companies public even while they were bleeding losses. Individual investors, believing that the companies would soon generate profits, readily bought the shares.
However, that hope evaporated in mid-2000, and investors dumped the stocks in one of the worst market beatings ever. Many venture capitalists still own a stake in those companies, albeit at much lower levels.
A few of the valley's Fastest 50 have made money for all of the venture backers, even the late ones. For example, Kleiner Perkins Caufield & Byers was the first VC firm to invest in blockbuster Sunnyvale networking company Juniper Networks. They made many more times the return realized by later investors, among them Lucent Technologies and 3Com Ventures. Still, even these later investors have made millions of dollars -- despite the 93 percent drop of Juniper's stock to $10.95 late last week from a high of $244.50 last year.
San Carlos medical company Conceptus was the only Fast 50 company whose stock rose over the past 12 months. That stock had a rocky start, crashing in 1997 when its first product didn't work out shortly after going public. But the company's stock rose strongly this year after it launched a new birth-control-procedure product in Australia that helped boost sales.
``We struggled a long time with that company,'' says Thomas McConnell, a partner at New Enterprise Associates. He invested in the company at its founding in 1992, and sold it after it went public in 1997, realizing a return of two or three times its original investment of just over $3 million.
Many other investments are still too close to call. For example, Sunnyvale's Internet infrastructure firm, LoudCloud, the fourth-largest company among the Fastest 50, first went public in March. Venture firms are prohibited from selling stock for six months, according to SEC regulations, which means venture firms can only begin to sell this month.
In the meantime, LoudCloud's stock has plummeted to $1.35 from its IPO price of $6. The company's later investors, including Focus Ventures, Amerindo Investment Advisors, Integral Capital Partners and Octane, have clearly lost money.
The company's earliest institutional investor, Benchmark Capital, is still making money on the investment -- at least on paper.
But Andy Rachleff, the partner at Benchmark who made the investment, said his firm doesn't plan on selling the stock anytime soon: ``We think extremely highly of the company, and won't be ready to distribute the shares for a while.''
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Contact Matt Marshall at mmarshall@sjmercury.com or (408) 920-5920. |
