VC Guru Sees Irrational Exuberance in Web Boom

The Internet investment scene is in the throes of a gold rush mentality that is driving valuations higher across the board based on a small number of notable startup successes, one of the venture capital industry’s pioneering members said.

Sky-high market capitalizations for the likes of Groupon, Twitter and Facebook are creating untenable expectations for the investors who provide the early financial backing for young web companies, Alan Patricof, founder and managing director of New York-based Greycroft Partners.

“We’re going through a period of irrational exuberance at the moment for the most part, which is really caused by a certain limited number of very exciting success stories,” Patricof told Reuters Insider in an interview.

Facebook, for example, sports a putative valuation of more than $70 billion. That figure is based on efforts last month by a group of shareholders to offload a big stake in the secondary market for private company shares.

“It’s beginning to set the benchmark of pricing for companies that go all the way down the line and may not be appropriate to benchmark off those 10 or 13 companies that everybody knows and is very familiar with,” Patricof said.

Patricof was an early player in the VC business, forming Apax Partners in the 1970s and becoming an early investor in Apple and America Online. He left Apax to start Greycroft in 2006.

The rebound in the tech startup scene is beyond belief, Patricof said.

“I’d say the proliferation of startups today is inconceivable,” he said. “Maybe that’s the wrong word; it’s hard to conceive how many there are … You go to the New York Tech Meetup, which I was at last week, almost a 1,000 people were there.”

And the startups are finding plenty of backers. More than $5 billion of VC money was put to work in the Internet space in the first four months of 2011, according to Thomson Reuters Deals Intelligence data. That puts this year on track to be the busiest in dollar terms since 2000, when more than $55 billion was sunk into Internet startups.

Today’s Web entrepreneurs have a markedly different end-game in mind, however. Ten years ago, Patricof said every one of his portfolio companies pitched an initial public offering as its exit strategy.

“Today? Not one of them,” he said. “We have 45 companies in our portfolio, two funds and I don’t think I saw the word IPO as an exit strategy in any one.”

The fact that the IPO scene is not as robust as a decade ago does not mean that this boom is without risk, though losses this time will not be nearly as widespread.

“There are going to be a lot of failures. A lot of companies won’t get additional rounds of financing,” Patricof said. “I don’t think there’s going to be dramatic losses because I think at these early stages there’s a reasonable amount of money — they’re testing out concepts really.”

“They’re all not going to make it but we’re going to see some probably some spectacular companies coming up through this process. It’s inevitable. You can’t have this many startups and not having a lot of successes, along with a lot of failures.”