Protect Thyself –

Deny it all you want, but the world of venture capital has changed. From a gang of investors and entrepreneurs who were joined at the hip, it has grown into an industry that requires nametags. As Morgenthaler Ventures’ Bob Pavey puts it: “We are an asset class now, heaven forbid.”

That mature designation is the inevitable result of the unprecedented influx of new money into venture funds in the past several years, which spawned more and larger venture funds beholden to a far greater number of limited partners. With that maturation has come a price: In the past, when the market turned down, most members of the venture capital club attacked the bad times by helping to build the next great startup that would carry everyone back to profitability. You didn’t dare burn a bridge because you would probably need (or at least run into) that LP, GP or entrepreneur down the road.

Today that sentiment is gone. Members of the venture capital industry are now more inclined to confront economic problems by attacking each other through litigation and other measures-whether it’s an LP suing a GP, an entrepreneur suing his backers, a GP suing another GP or a public LP breaking nondisclosure agreements.

Reid Dennis, a founder of Institutional Venture Partners and an investor throughout the history of venture capital, says he’s never seen anything like it. “The lawsuits that we are seeing now, that’s a new phenomenon,” says Dennis, 76. “In previous downturns, people felt that lawsuits were counterproductive. It has always been much more profitable to go and find the next investment than try and find money by filing a lawsuit. One of the things driving these lawsuits is people who have given up on investing. Suing is a way of shifting the blame from your own stupidity to someone else’s.”

On its face, Dennis’ take on what’s going on appears to be on the money. But, it could be argued that the rules that applied in the clubby days of VC just don’t apply to the massive industry it has grown into-and the weight of the financial stakes. For example, Benchmark Capital sued Canadian International Bank of Commerce (CIBC) this past summer, alleging that CIBC and portfolio company Juniper Financial conspired to wipe out $115 million worth of investments in Juniper by Benchmark and other investors. It was the first suit Benchmark ever filed. Some will argue Benchmark should’ve just walked away from the $25 million loss that it personally suffered and focus all its energy on new deals. But at what point is the loss so large that it can’t be ignored?

Josh Lerner, a Harvard professor who has studied private equity extensively, says the most recent downturn in the VC industry will have a lasting impact. The most profound shift, and something that will touch everyone in the business, is disclosure, he says. Venture capitalists, like those in other mature asset classes, must be prepared to make their financial activity more transparent. “In some ways venture capital has operated as a private club for a long time,” Lerner says. “I can’t help but think that opening it up to greater transparency and clarifying it in the long run will very much benefit the industry and reward investors.”

Like, Lerner, U.C. Berkeley Business Prof. Andrew Isaacs sees an upside to the skirmishes that have broken out on the venture capital landscape. “The outcome will be a clearer understanding between LPs and GPs and other participants in the industry,” says Isaacs, executive director of Berkeley’s Management of Technology Program. “What you will see are better contracts, clearer contracts and an adjustment of expectations, not an adjustment of modus operandi.”

Isaacs points out that those who play in the venture capital arena are among the most sophisticated investors out there. “These are not FDIC-approved investments, and all parties have their eyes wide open-they always have,” he says. “But having eyes wide open in the future will be accompanied by thicker documents.”

Some VCs would certainly take issue with Lerner and Isaacs’ positive spin on these recent developments. But for now, it appears that the old rules of VC don’t apply in this new world, and the safe bet for VCs, their investors and portfolio companies is to operate under the assumption that the venture world will never go back to its hand-shake roots. For venture firms, it’s becoming that much more important, then, to know how to protect themselves.