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In Silicon Valley there is a definite pecking order among venture capital firms, and Sequoia and Benchmark are near the top, getting into the most sought-after deals. (Kleiner Perkins Caufield and Byers, which made its money and its name on early investments in Netscape and Amazon.com, has long been at the pinnacle.) Sequoia and Benchmark are on top now largely because each of them has had a single stunningly successful Net investment. For Sequoia, it was Yahoo; Sequoia provided $1 million of startup money for a 25 percent ownership in the company; Yahoo's stock is now valued at $26 billion. Michael Moritz, the Sequoia partner responsible for backing Yahoo, is also the partner who sits on Webvan's corporate board. Meanwhile, Benchmark is one of Silicon Valley's younger venture capital firms -- just four years old. Benchmark was the initial investor in the auction site eBay; its share is now worth about $880 million.

But here's the big irony of the Silicon Valley pecking order: The biggest advantage of having backers from the club of top money managers is the mystique they bring. By their vote of confidence in a company, the top venture capitalists attract other investors, who put in even more money in later rounds of financing. Webvan counts as investors not only Softbank and Goldman Sachs, but also the French billionaire Bernard Arnault, newspaper company Knight-Ridder and CBS. All of them have ponied up tens of millions in financing to go along for the ride with Benchmark and Sequoia.

Well, guess what. Once a company has raised over $400 million, it's almost certainly only a very short step away from selling stock to the public. Chances are that investors will bite once business magazines report that a company has a "value" of $4 billion. What that means is that the last 6.48 percent of the company was sold for $275 million, which implies that the whole company is worth $4 billion dollars -- even though Benchmark and Sequoia got big pieces of the company early on, for much, much less. If the company does go public, the investors in the public markets will no doubt be eager to get stock in a company that comes with the imprimatur of gilt-edged money managers. On top of it all, the fact that Webvan and Yahoo share Softbank as an investor (in fact, Yahoo CEO Tim Koogle has a seat on Webvan's board of directors) implies a deliriously full future for investors eager to bet on the future giants of the Net.

A scenario a lot like this played out last week, when investors bid up shares in Drugstore.com, an online pharmacy backed by Amazon.com and Kleiner Perkins, the most prestigious and powerful of all of Silicon Valley's venture capital firms, by 179 percent in one day. The stock of Drugstore.com, a company that opened for business five months ago, is now worth just over $2 billion. (Amazon and Kleiner Perkins have also teamed up on a direct competitor to Webvan -- HomeGrocer, which is already operating in Seattle.)

There is not a single venture capitalist who does not say that his goal (they are mostly men) is building "the next Microsoft." But here's the ugly truth: It makes no difference to a venture capitalist's returns if a company grows to dominate an industry or goes bankrupt five years after selling stock to the public. A Boston Market (formerly Boston Chicken) can be as good as a Microsoft because a venture capitalist needn't wait for the company to prove itself; not long after a company goes public, the venture capitalists can cash out. In fact, a Boston Market -- a high-flyer which went bankrupt -- can be better than a Microsoft, because all of Microsoft's stock taken together wasn't worth a billion dollars until the company had been around for nine years.

What venture capitalists are looking for is -- don't laugh -- a "liquidity event." That's biz speak for selling a company or taking it public, turning their ownership stake into cash. Typically, a year after a company goes public, venture capitalists are allowed to sell their stake. Sometimes they will do that. More often the venture capital firm will split the stock up among investors in its fund, letting them quietly sell it in small bits and reap huge winnings. Or they might hold it, if the investors think the company really will be the next Microsoft.

The upshot is that venture capital firms are not in the business of taking a long time to build companies. At one time, they might have been, but that is certainly not true in the age of the Net. Like Masayoshi Son at the San Francisco conference, they are in the business of retailing dreams of corporate grandeur. If they succeed in selling those dreams, they can make a lot of money. Whether they come true, however, rarely need be their main concern.
salon.com | August 2, 1999

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