Cover Story: The Big Squeeze –

Bigger + Faster = Better

That was the core equation of the New Economy. Stir in a little moxie and what emerges is an explanation for the rampant expansion of almost every bank, venture firm, tech company and bagel shop during the economic boom of the late 1990s. Once the new millennium began, however, market pressures forced most of those businesses to begin scaling back and slowing down. But venture capitalists resisted … until now.

With a few notable exceptions from corporate venture groups, the VC community believed it was insulated from all that was going on around it. After all, this is a collective whose compound annual growth rate was 50.8% between 1993 and 2000. Not even a November 2000 decision by Silicon Valley stalwart Crosspoint Venture Partners to decline $1 billion in committed capital could stem the unfettered growth.

The most poignant example of this head-in-the-sand mentality occurred just weeks after the Crosspoint giveback, when fellow early-stage investor Mohr, Davidow Ventures (MDV) closed on $847 million for its seventhinvestment vehicle. Management of the Menlo Park, Calif.-based firm brushed off suggestions that it would be difficult to put its new-found money to work, even though the firm’s $300 million predecessor fund was not yet fully invested.

“Because it came down from such an inflated level, the results now are more dramatic, more calamitous. But this was and always will be a super-cyclical industry. It is marked by long periods of illiquidity in the past, as now. It may seem like this won’t be over, but it will be.”
Dick KramlichCo-founder/General PartnerNew Enterprise AssociatesYears as a VC: 30

“We’re still seeing a lot of quality entrepreneurs,” MDV partner Rob Chaplinsky said in a December 2000 interview with Private Equity Week, a VCJ sister publication. “A lot of comments about there not being deal flow in the market are tied to the current fortunes of Nasdaq and short-term-oriented views.”

A year and a half later it seems that Chaplinsky was the one who needed his glasses adjusted. The world, indeed, had changed.

For one, the window for initial public offerings virtually shut. Between 2000 and 2001, the number of U.S. venture-backed IPOs plummeted from 229 to just 37 and the amount raised by VC-backed IPOs dropped from an all-time high of $21.1 billion to $3.1 billion.

With the IPO window virtually shut, venture-backed companies turned to mergers and acquisitions with modest success. A total of 322 deals got done in 2001, up from 299 the year before, but the value of those deals fell 77% in 2001 from a disclosed $67.4 billion in 2000.

Faced with bloated portfolios, VCs just didn’t have the room to add many more. After seven years of funding ever-larger numbers of startups, they started to turn off the tap. They backed 3,643 companies, or 41% fewer than they did in 2000.

In January of this year MDV stepped forward and admitted that Fund VII was too large. It told limited partners that it was cutting the vehicle by 20%, or about $170 million. That set off a chain of fund reductions at several brand name firms, starting with Kleiner, Perkins, Caufield & Byers in March (