Naming conference rooms for winning portfolio companies was once a grand tradition at Institutional Venture Partners. Seagate Technology has one named after it, in deference to returning more than 100 times IVP’s investment.
At one time, the Excite@Home room was the largest in IVP’s office on Sand Hill Road. At its high, with a market cap in excess of $15 billion, Excite’s returns dwarfed those of nearly all other IVP investments. Today, the former Internet high-flyer is bust, and its conference room has been renamed the Everest Room.
When Reid Dennis, the 76-year-old founder of IVP, hears the name Excite, his twinkling eyes lose a little of their sparkle. It wasn’t that Excite was so special to him; he didn’t even play a major role in its funding. It’s that it didn’t fulfill the one mission that Dennis and the “Old Guard” venture capitalists seek for all portfolio companies: It didn’t become a fundamental business-one with growing revenue and profits, one that put people to work, paid taxes and contributed to the country’s Gross Domestic Product. Excite never had a prayer.
Now is a perfect time to reflect on the disaster of Excite and the other smoking craters left behind in the past few years. The frenetic pace of this business rarely slackens, so when it does, you don’t want to miss the opportunity to take a step back and consider what has happened and what it all means. Who better to put it in perspective than the guys who started it all? The Old Guard, if you will. Dennis, Bill Draper, Pitch Johnson, Arthur Rock and Paul Wythes. Between them they have more than 200 years of venture capital experience, and they have
collectively created more than 1,500 companies, some of which have ranked among the largest in the world-Amgen, Apple, Boole & Babbage (acquired by BMC Software), Intel, Rolm (bought by IBM), and Tellabs, to name a few.
They were the first of the first, the five most pioneering venture capitalists. Sure, there are other industry fathers, like Gene Kleiner, Dick Kramlich, Burt McMurtry, Tom Perkins and Don Valentine. But Valentine didn’t start his first firm, Capital Management Services, until 1971. A year later, Kleiner Perkins Caufield & Byers opened its doors, then came Kramlich’s New Enterprise Associates in 1978. McMurtry’s Technology Venture Investors didn’t pop up until 1980.
Twenty-two years is certainly a long time, but you have to put those years in context. Dennis, Draper, Johnson, Rock and Wythes each started doing venture deals-then known as “special situations”-about 40 years ago (see “The Old Guard Are …,” right). Dennis actually dates himself back to his first investment in the fall of 1952 as a private investor with other San Francisco financial district side-betters.
The Old Guard were among the first, if not the first, to go door-to-door across Silicon Valley, looking for deals to fund with their small syndicates of venture capital dollars. This is their story, or at least part of it, their lessons and wisdom gleaned from having built some of the largest corporations in the world. “We invested in companies with our stomach linings and spent a lot of time blowing on the dice,” says Johnson, who helped start Amgen from nothing only to watch it grow into a multibillion-dollar giant. “But we also knew it takes five to seven years to get to earnings. It’s not something you did in just 18 months.”
The end game was simpler then. “We just built companies to be listed on the New York Stock Exchange,” says Rock, 75, arguably the grandfather of the industry. It was a time when VCs still had time to think, because institutional limited partners weren’t part of the picture, pressing GPs for big numbers. “There wasn’t this need to produce returns, returns, returns,” says Rock.
His investment in Intel may be the model for the ideal venture capital deal, one that took an idea and turned it into an industry standard. He was approached in 1968 by two members of the legendary “traitorous eight”-a group of engineers from Fairchild Semiconductor he had backed once before. Bob Noyce and Gordon Moore wanted to start a new company. Like the combustion engine and electricity, the semiconductor had the potential to change the world. Rock saw the potential and agreed to help raise Intel’s first $2.5 million.
It was an investment built on history and trust. Rock trusted Noyce and Moore so much that “I’d have let them put their own hands in my pockets,” he says. Rock himself wrote Intel’s first business plan and term sheet. “All of one-and-a-half pages combined, and we weren’t interested in how soon you could get your money out or who got what shares,” he says. No one signed it and there wasn’t even a handshake. Rock and his investors got half the company, and the entrepreneurs got the other half. Simple.
Today, venture capital is anything but simple, and it all flows from the money that has rushed into VC-from mere millions in the 1960s to more than $100 billion today. The problem, as Johnson and others see it, is that too much money has done more harm than good at a time when no one wants the “product” that VCs are in the business of creating: taking private companies and turning them into publicly-held enterprises. The average VC today is more concerned about IRR than about GDP. Back in the day, “everything was at cost unless we wrote it off or took it public,” Draper recalls.
Along with the flood of money came a flood of people. More than 8,000 people work in venture capital today, and at least half of them have been in the business five years or less, according to the National Venture Capital Association.
“A lot of these VC firms went out and hired young whippersnappers, but that was the biggest mistake the industry made,” says Dixon Doll, a 20-year veteran of the industry and founder of Doll Capital Management. There was a misconception “that if you bought talent, and not operational experience, that would lead to success,” agrees Kevin Kinsella, founder of San Diego, Calif.-based Avalon Ventures. “MBAs in VC firms had never bet a dollar of their own money on a two-legged mammal in their life. How were they supposed to translate what they knew into how to bet on real individuals?”
In contrast, the Old Guard were veterans of industry before they set foot in venture capital. Draper and Johnson had both worked for the same steel mill in Indiana, Draper in sales and Johnson on the factory floor. Wythes was in technical sales and marketing for Honeywell and then M&As for Beckman Instruments. And Dennis and Rock were both engineers by training and finance guys by experience.
It isn’t just that the VCs who jumped into the business in the last five years lack operational experience. They also have a commitment problem, an unwillingness to work hand-in-glove with entrepreneurs, Rock asserts. “These guys didn’t have time to go to board meetings … they weren’t really interested in building great companies,” says Rock, who claims he’s never missed a board meeting and often talks with his entrepreneurs once a day.
“Venture capital is a very productive portion of the American economy,” says Draper, “but it has to be handled by mature individuals with patience, solid judgment, an unusual sense of people, markets, and, most of all, humility, which was all but lost in the late 1990s.”
Venture capital is an industry reeling from it’s own five-year excesses despite its 35 previous years of value creation. “During the late 1990s there was far less emphasis on watching deals and too much emphasis on fancy cars and houses … and entrepreneurs were allowed to get sloppy,” Draper says. “We were all too mesmerized by the gold watch.”
Even the Old Guard weren’t immune from the lure of instant returns, he admits. General Atlantic Partners, an LP in Draper Richards, could not have been happy when one of Draper’s own Internet plays, BarterTrust, went bust. As a result, Draper Richards hasn’t done a deal in 12 months. Wythes’ Sutter Hill, too, had its own dot-bombs-Agribiz.com, now dead, and Lucy.com, still hanging on.
Clearly, the guys who started VC are not perfect, but they think they know what it will take to get the industry back on track. The fundamentals that helped them create more than 1,500 companies still apply today. If the mistakes were painful, the solutions they offer seem fairly simple:
Don’t Take Money From Strangers
To escape many of the pressures LPs put on GPs, most of the Old Guard invest their own money or are very selective about the limited partners they choose. Investing principles must be aligned. For Johnson and Rock that means investing their own capital. For Dennis and Draper it means having history counted in decades with their limiteds. Wythes’ Sutter Hill had just one LP for nearly 20 years, as it built an evergreen fund that grew from $6 million in 1970 to approximately $500 million today. “The annual review was lunch once a year,” he says. And the relationship was allowed to continue or dissolve every four years.
When Sutter Hill parted ways in 1986 with its one LP, Genstar, a Canadian manufacturing concern, it carefully chose seven new LPs. For those VC firms now at odds with their own LPs, it’s a story worth paying attention to. The mandate in picking the new partners was that they had to share the same long-term view that Sutter Hill and rest of the Old Guard hold so dear. “Foundations and university endowments are the two best investors for VCs because they don’t come and go,” says Wythes. As a result, the Irvine Foundation, MIT, Princeton, Stanford, and Yale all back Sutter Hill, and to this day the firm remains an evergreen fund.
Don’t Panic, It’s Cyclical
For those who question the Old Guard’s wisdom as nothing more than hindsight, remember that these guys weathered worse economic cycles than today’s. When Kramlich joined Arthur Rock & Co. in 1968 the two VCs faced what Kramlich calls a “wasteland economy.” “It was the worst possible time,” he says. “We were in the middle of the Cold War, we had double-digit inflation, high interest rates, and in 1974 there was just one high-tech IPO.” Still, of the $10 million they raised in 1969, Rock and Kramlich were able to invest $6.25 million by 1977 and distribute $40 million to their investors. Arthur Rock & Co.’s investment style was as much about singles and doubles as it was about home runs.
Unfortunately, with the billion-dollar funds in existence today, it’s become more and more prevalent to aim for the bleachers. It’s the two out of 10 home run philosophy. That’s a tough mandate in times when so few companies are able to go public and there are so few interested buyers. “At a more basic level,” says Dennis, the problem with the home-run strategy is “that you end up leaving a whole lot of carnage on the side of the road, when venture capital itself could be a business that is far more creative, constructive and productive.”
Cut Your Fund Size
The institutionalization of venture capital is conceivably the single worst thing that has happened to the industry. It has taken it from a long-term view of building companies for the fun and privilege of it, and turned it into a slugfest aimed at pleasing institutional limited partners, who themselves are under pressure to show double-digit returns.
Kramlich’s NEA is a prime example of this big money quandary. When NEA started in June 1978, it raised a total of $16.4 million. It did well, and the firm wound up with a $60 million portfolio. As successive funds were raised the numbers grew wildly. From $125 million for NEA III to $200 million for NEA V and now, amazingly, to $2.3 billion for NEA X. That’s a lot of dry powder to deploy, and some would question how the firm, or any firm, could justify the massive management fees on such a fund. Kramlich argues that he has created a model that combines the best of the old and the new.
First, there is both a formula and a cap for calculating management fees at NEA. And unlike most firms-maybe any other firm-NEA gives back management fees to its limiteds at the end of a fund’s life. Second, NEA’s limiteds are afforded unheard of transparency into the workings of the firm, with detailed weekly reports distributed to all of the main limited partners. Third, and finally, partnership meetings are still based on the principle of a handshake, and Kramlich is adamant that the business is still, by and large, fun. The system is working, judging by the fact that NEA has had eight companies that have each gone from zero to a $1 billion market cap, including Ascend, Immunex, Juniper Networks and 3Com.
But Draper is quick to point out that NEA is the exception, not the rule. The industry isn’t built to scale, adds Wythes. Another problem, he says, is the healthy practice of sharing deals (syndication) dried up with the emergence of mega-funds like NEA. Billion-dollar funds can’t share a deal because they need to invest enormous amounts of money to have any hope of showing returns to their LPs “When was the last time some VC invited me over to their offices the way we used to?” Wythes says. “Never. It just never happens.”
Know Your Entrepreneur
Betting on the right entrepreneur, someone you can trust, is a mandate upon which the entire Old Guard places their faith. It’s why Draper, Johnson and Wythes each fondly remember investing in David Lee in the 1960s. Even though Lee had just immigrated to the United States and had just one idea on his mind (the daisy wheel printer), he was someone they liked and trusted. As a result, his company, Qume, turned out to be a winner, returning $150 million on a $3 million investment. To this day it remains one of the three Old Guard’s most rewarding investments, as they’ve watched Lee move along in Silicon Valley, helping start more companies as a result of his own success.
This sense of trust should not be underestimated as the venture business struggles with how to effectively deploy the largest amount of dry powder in its history. Rock’s own lessons are a testament to this. His initial impression of Steve Jobs and Steve Wozniak was that they were two bearded hippies who “no one would have really thought were bankable.” Sutter Hill passed on the duo for that very reason. But, Rock knew Mike Markkula, the original investor in Apple, so he agreed to put $87,000 of his own money in the company. “I invested because I liked Mike and I knew he wouldn’t screw up,” he says simply.
Diasonics was a far different story. That one came through the mail. “I think [the entrepreneur] found me in the phone book under venture capital,” says Rock, completely serious. And Rock would pay the price for not knowing his entrepreneur. Diasonics was the first company to build MRI machines. The company did well enough to go public, but GE and Siemens later came along with their deep pockets and ran it out of business.
Rock’s real lesson came later when he learned that in order to keep Diasonics alive, its CEO was cooking the books, shipping product to warehouses and calling it revenue. If that offense were committed today it could have landed the CEO and Rock, who was chairman, in jail.
That was the last deal Rock ever did without having some history to back up his investment. “You’ve got to have a guy you can trust, who’s got fire in his belly,” he says. “Does he see things as they are, not as he wants them to be? That’s what matters.”
Don’t think for a minute that because Rock is well into his retirement years that he spends his time on the golf course. He and Draper are the most active investors of the Old Guard. The only difference these days is that they invest in companies and causes closer to their passions. Draper International concentrates on financing companies mostly in India and a few in Asia-areas that Draper is intimately familiar with following his tenure as head of the Export-Import Bank. Rock, meanwhile, seeks investments with more of a social purpose these days-deals that are as much about building companies as they are about solving some of the world’s problems. Among Rock’s projects are a company with a better way to treat Alzheimer’s and one that’s trying to solve the problem of nuclear waste disposal. A third, still in the planning stages, aims to build drones for the military that can fly across the Atlantic on half a gallon of gas. “They have to have some larger social meaning to me now beyond the satisfaction we have all found in building real companies that put people to work,” Rock says.
As for the other members of the Old Guard, they still invest but semi-retirement is more top of mind. Johnson walks around with a golf glove hanging out of his back pocket. Wythes is in and out of Sutter Hill, while Dennis is part-time at IVP: He spends more and more time restoring old planes and flying them around the world.
If anyone has earned the right to retire, it’s the Old Guard. But, because of who they are and where they’ve been, you can’t really ever see that happening completely. Even with the excesses and the institutional growing pains, “I still wake up in the morning and love the job,” says Wythes. “At the same time that you’re creating jobs, helping the economy and paying taxes, you’re conceivably helping companies make the lives of mankind that much better.” An important message to remember as the venture capital business seeks to find its way after having suffered perhaps too many self-created excesses.
Peter D. Henig is a freelance writer who specializes in writing about entrepreneurialism in Silicon Valley. His last cover story, “Back to School,” appeared in the July issue of Venture Capital Journal.