Cover Story: Rebuilding the Franchise –

When sportswriters are stuck for apt analogies, they generally turn to war. When business writers are caught in a similar pickle, they bypass battlefields and move directly to the ball fields.

Not wanting to break with journalistic tradition, VCJ has opted to characterize the 2003 venture capital experience as a “rebuilding year.” In sports terminology, this means that a team willingly takes strategic steps backward in the hopes of taking future leaps forward1. It also can apply to a financial market that slowed down its investment pace and pared down its investor rolls in preparation for the years ahead.

Almost all 2003 venture capital reductions – whether they involved disbursements, fund-raising, performance or personnel – were brightened by the underlying belief that something better would be waiting right around the solar bend. For example, many follow-on financings were made in order to prep companies for public exits, rather than to just temporarily stem the bleeding.

The significance of such optimism is that it illustrates the key difference between the 2002 and 2003 venture capital markets. Investors retreated in both instances, but the 2002 VCs fled for fear of otherwise being trampled by the runaway recession. The 2003 VCs, on the other hand, recoiled in order to enable

future progression, in order to rebuild. Consider it the difference between turning tail and walking backward.

It’s certainly possible that much of last year’s optimism will prove illusory, and that today’s VCs will someday ask each other, “What were we thinking in 2003? How did we not see the pharmaceutical market collapse coming?” But until everyone debates such issues around the Silicon Valley Retirement Home’s shuffleboard court, let’s just say that 2003 was the beginning of a work in progress.

2002 Hangover

It’s now time to discuss war. Not the analogical kind favored by sportswriters, but the real kind favored by hawkish politicians. Why? Because the 2003 calendar year was split more into pre-war and post-war periods than into separate fiscal halves or quarters. Or, to be more specific, it is best analyzed by looking at what happened before and after May 1, which is when President Bush landed aboard the USS Abraham Lincoln and said, “Major combat operations in Iraq have ended.”

The pre-war period actually recalled the running-scared mentality of 2002, right down to the continued practice of fund size reductions. The scale was slightly smaller than the previous year’s bloodbath – $1.5 billion cut in 2003 compared to $5.7 billion cut in 2002 – but it also happened to include five firms that put already-reduced funds back on the chopping block.

Most notable among the repeat reducers was Mohr, Davidow Ventures, which had kicked off the whole fund cut phenomenon in February 2002. Eleven months later, the Menlo Park, Calif.-based firm marked its 20th anniversary by closing two satellite offices and cutting its seventh fund by an additional $200 million, or 31 percent. Also cutting funds for a second time were Accel Partners, Redpoint Ventures, Trinity Ventures and Walden International. Notable new cuts came from firms like Sprout Group and Battery Ventures.

Yale University also retreated from the private equity market by cutting its private equity allocation by 30 percent.

All of this pre-war retreat, of course, was within the context of a larger economic framework that included stock market declines and continued job losses helped along by the “offshoring” phenomenon that came to the fore in 03. The American Electronics Association estimated that 230,000 tech jobs were lost nationwide last year – not nearly as bad as the 540,000 that went away in ’02 – but still a brutal decrease.

One high-profile casualty of the technology contraction was venerable Silicon Valley law firm Brobeck, Phleger & Harrison, which had to shut its doors after failing to consummate a proposed merger with Philadelphia-based Morgan, Lewis & Brockius. Venture Law Group, co-founded by famed VC attorney Craig Johnson, also took a financial beating, prompting it to merge into San Francisco’s Heller Ehrman White & McAuliffe.

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