Sandy Robertson remembers well an early venture capital fund that he helped put together. The year was 1972, and the fund's target, a whopping $10m, turned out to be overly ambitious. After months of struggle on the fundraising trail, the debut third-party vehicle to be managed by Eugene Kleiner and Tom Perkins closed on $8.4m. “We were afraid that if we didn't close we'd lose some of what we'd already raised,” says Robertson.
The firm that became Kleiner Perkins Caufield & Byers has the exact opposite problem these days – it must now carefully manage the flood of investors that want access to the Menlo Park, California venture capital colossus. Kleiner Perkins reportedly placed a cap of $500m on its latest partnership, Fund XI, well below the capital demand for the vehicle. That target is far less than the firm raised in June 2000, when Fund X easily drew $1bn, putting it in a league with more than 20 other venture capital firms that crossed the mega-fund threshold at the peak of tech and telecom mania.
Would I turn back the clock? No. The opportunities are so much more diverse now
Many of those funds have since been drastically cut down to size. In 2002, US venture capital firms gave back almost as much capital (an estimated $5bn) as they raised ($8.6bn, according to the National Venture Capital Association). While the contemporary venture capital industry is still recovering from a massive hangover brought on by the dotcom party of the late 1990s, the institutional commitment to venture capital remains strong. This ensures that the industry will never return to the clubby, early days of the 1960s and 1970s, when everybody knew everybody and $1bn was a big deal.
“The numbers in the industry have added not one, but two zeros,” marvels Robertson, the co-founder of pioneering technology investment bank Robertson, Stevens & Co, who introduced Kleiner and Perkins to each other after the two separately approached him about raising a fund.
The first Kleiner Perkins fund put its $8.6m to good use. Out of that vehicle came two homeruns – Tandem Computers (bought by Compaq in 1997 for $3bn) and biotech giant Genentech (current market capitalisation $40bn). Success stories like these “started getting people's attention” says Robertson, and by the early 1990s, the venture capital market was flush with big-dollar commitments from large institutional investors, transforming the industry into something its early practitioners never envisaged.
‘Didn't have a clue’
A career in venture capital is today much sought after by business school students and financial professionals looking to move to principal investing, where they know significant fortunes can be built. But in the late 1960s and early 1970s, when many of today's senior partners were getting their starts, the US venture capital ‘industry’ was an obscure collection of bootstrapping entrepreneurs and technophiles who saw opportunity where Wall Street saw only trifling dollar amounts. Those who entered or stumbled into venture capital often came from unusual and disparate backgrounds.
In 1967, Kevin Landry was seeking a summer job between his two years at the Wharton MBA program in Philadelphia. At the time, Boston investment bank Tucker Anthony & Co was creating a venture capital platform called TA Associates, and the man in charge of the project, Peter Brooke, came to Wharton to look for recruits. “[Brooke] said he was in the venture capital business,” recalls Landry, now the CEO of TA Associates. “I said, ‘Oh, I love that business.’ I didn't have a clue what it was.”
Landry says TA Associates remains his first and only white-collar job. His previous work experience included brewery worker and taxi driver. The later skill set proved crucial, as TA Associates' early deal flow came largely as a result of Landry and his team driving to the industrial parks surrounding Boston, writing down the names of companies, and contacting the founders to see if they might be interested in growth capital.
TA Associates, in fact, represented an early institutional approach to private investing. Venture investing in those days was mostly done through networks of personal and family relations that today seem quaint. In the 1950s, remembers Bill Draper, venture capital investing was dominated by a small handful of East Coast families, including the Rockefellers and the Whitneys. In 1958, Draper's father, General William H. Draper Jr, founded the first professional West Coast venture capital firm, Draper, Gaither & Anderson. It was here that Draper cut his teeth in venture capital before founding a firm of his own with friend Franklin ‘Pitch’ Johnson in 1962.
Draper and Johnson had met while working for the same industrial company, Inland Steel. Draper was a salesman while Johnson was a foreman on a factory floor in East Chicago, Indiana. “I liked the smoke and the flames,” Johnson says. But he noticed that the grandchildren of the company founders had thousands of shares more than he did, which stimulated his interest in equity investing.
Johnson's eight years in a steel mill had given him an intense education in operations and production and left him with a hunger to learn more about technology. After moving to California's Bay Area to found Draper & Johnson Investment Company, Johnson took a series of science classes at Stanford University that he now describes as ‘an important developmental step’ in his growth as a venture capitalist.
The investment climate of early Silicon Valley and, to a certain extent, the start-up scene surrounding Boston, during the late 1960s and early 1970s, was marked by relatively modest amounts of money invested by a small handful of people. The target entrepreneurs were often visionaries who had to be persuaded of the business merits of their innovations.
“We'd look for companies whose names sounded like they were technology companies,” says Draper. “We'd knock on their door and ask them what they did.”
The entrepreneurs would often be puzzled about what Draper & Johnson did. “Venture capital was not a word that was well known then,” Draper says.
He remembers his wife having a hard time explaining to friends what he did for a living. On Wall Street, Draper & Johnson's business was only slightly more recognised. “We were the guys who knew what was going on with flaky, little companies,” he says.
In a sense, the venture capital investment proposition today is the same as it was 30 years ago, except for the amounts. “We'd tell [the entrepreneurs] that we'd put in the money and they'd put in the blood, sweat and tears,” says Draper. The investment capital then was of a magnitude that many of today's venture capitalists would consider child's play. For example, in 1967 Draper & Johnson backed a software company called Boole & Babbage with a total of $200,000. In 1998, the company was finally sold to BMC Software for $900m, after several US presidential administrations and 30 years of what Johnson calls ‘growing pains’. “The mentality in those days was not to build overnight successes,” Johnson adds.
TA Associate's Landry says the average deal size for his firm's first fund was between $100,000 and $300,000. As the firm grew assets under management, it struggled to find ways of investing greater amounts of capital. “I remember when we set a minimum deal size of $500,000 and everyone howled,” says Landry. “No companies got financed with more than a million dollars,” recalls Robertson, whose firm often invested alongside its clients. “If a company didn't make it on that million, they went under, so they really horded that cash.”
Robertson notes that today it is not uncommon to see young companies receive $5m in a first round, then $10m, then, ‘if it's still not profitable, another $25m’.
Johnson says he and Draper learned that success in venture capital requires far more being invested than just capital. “You really had to care whether you succeeded or not, almost in the athletic sense,” says Johnson, the son of a Stanford University track coach. “We found that we had to spend a lot of time with the companies. People were interested in our input. You had to share with the entrepreneur an emotional commitment to winning. I'd say the investing business is part of venture capital, not the other way around.”
Thirty years ago, the few individuals that called themselves venture capitalists spent a great deal of time working next to entrepreneurs in an attempt to protect and grow sub-million dollar investments. Not surprisingly, venture capitalists during this era had close relationships with each other as well. “It was like a little club that everyone believed in,” says Landry. Johnson admits to a certain nostalgia for the days when “there were about 12 of us. There was a lot of camaraderie. We all had dinner about once a month.”
Growing and not going broke was considered a success
Competition for deals was less and sensitivity to risk was high. Richard Dumler, a partner at New York earlystage specialist Milestone Venture Partners, who started out investing the capital of Allstate Insurance, says: “I never saw a venture fail because of competition. You didn't see four, five or six well-funded companies in the same product set. Everybody in Silicon Valley knew who was doing what. If you needed to know about a certain company, there were lots of people you could call who would say, ‘Oh yeah, I looked at that, and here's why.' You could find out if anybody was doing a similar deal and track it. Now, it's damn hard.”
“Pitch and I never really wanted to do a deal by ourselves,” says Draper. “We always wanted to have partners. We were a knot of venture capitalists who shared deals. We shared information, too, because back then it wasn't so competitive and transaction-oriented.” Adds Johnson: “Now people don't talk about what they're doing.”
Other people's money
Increased competition between venture capital firms was just one of the changes that came to the industry as large institutions began to commit capital to the asset class in the 1980s.
In general, the returns being realised by the small club of venture capitalists were hard for the broader investment market to ignore, especially as erstwhile technology startups began to emerge as important companies – businesses like Fairchild Semiconductor and Apple Computer. In the highest-profile venture capital success, Federal Express – which had received capital from most of the US venture capital world – went public in 1978, demonstrating to many investors the enormous potential of early stage investing.
After respected institutions began investing in venture capital funds, the rest of the institutional world followed. “When Harvard decided to invest, that made it legitimate,” says Landry.
A major new group of investors were given the green light on venture capital when, in 1979, the US Department of Labor ruled that, under the Employment Retirement Income Security Act (ERISA), pensions investing in private equity and venture capital would not run afoul of ‘prudent man’ rules. With pension money flowing into venture capital funds, the early, clubby environment steadily vanished.
Until 1982, Johnson had invested his own capital in deals. His profile changed from bootstrapper to asset manager after he agreed to invest the capital of Stanford University in his deals. “At first I said, ‘Well, we don't manage other people's money,” says Johnson. But the technology industry had expanded, and access to greater amounts of capital had an appeal. He founded Asset Management Company specifically to invest Stanford's capital, and eventually brought in money from Harvard, Massachusetts Institute of Technology and Dartmouth College, as well as large corporations like AT&T and General Electric. He simply called up the pension funds which had just been cleared to allocate to venture capital.
Throughout the 1980s and 1990s, venture capital funds attracted an accelerating amount of capital, until they famously peaked in 2000 when 630 funds drew $107bn in capital commitments, according to the NVCA. With the increased amounts of money came greater competition among venture capitalists, pressure to put money to work, and a requirement to return capital to limited partners in a timely fashion – a schedule not always in sync with the actual growth of early-stage, speculative companies. The quick returns of the late 1990s helped raise investor expectations to unrealistic levels. Those expectations, of course, have since come crashing down, but not before creating a brief, surreal environment that every veteran venture capitalist refers to with a mixture of awe and disdain.
Milestone's Dumler says investors in the early, preinstitutional days of venture capital were typically better attuned to the long-term, risky nature of the strategy. “Back in the 1970s, the question was not, ‘How soon is this going to be liquid,’” he says. “The question was, ‘Are these companies going to go broke?’ Growing and not going broke was considered a success.”
There was a lot of camaraderie. We all had dinner about once a month
“I used to never hear anyone ask, ‘What's your exit strategy?’” says Draper. “But in the late 1990s, there was tremendous pressure to pump it up and go public.” Draper says that as the venture capital market has fallen back to earth, investors and venture capitalists alike have adopted a more realistic attitude. “If an entrepreneur says to me, ‘I want to get this up and running and exit in a few years,' then I know he's not the right person.”
No turning back the clock
To a man, the old-school venture capitalists remain optimistic about prospects for venture capital going forward, with some reservations. Landry has long since sworn off earlystage investing. TA Associates focuses on growth investments in profitable companies, which Landry argues have better risk/return ratios. Still, he says he believes venture capital will continue to create successful companies. “The wonderful thing about technology is that it is a renewable resource, in that it keeps changing,” he says.
Robertson, too, is now focused on mature deals. He is a partner at Menlo Park technology buyout firm Francisco Partners. Landry says that while the industry still needs to digest an overabundance of capital, ‘good ideas are still getting financed‘.
Dumler has remained faithful to the early-stage strategy, and says the current environment is far more interesting than the market of the 1960s and 1970s. “Would I turn back the clock? No. The opportunities are so much more diverse now,” he says. “The scale is just so much bigger.”
Johnson says the increased size of the venture capital market is permanent, and this is because the early-stage companies funded by venture capitalists have emerged as a fundamental underpinning of the US economy. Far from bemoaning institutionalisation, Johnson applauds the high standards and competition it has brought to the industry.
Draper says the presence of so much money in the industry means that ‘fantastic businesses’ started by ‘thinkers and visionaries’ will continue to get funded. But the increased capital has created a system of investment partnerships that do not always lead to the best investment decisions: “The whole idea of raising fund one, two, three, eight is not very good in the sense of aligning LP and GP interests. Very often, these funds are pushed onto the entrepreneur very fast so that the younger people in the firm can get a bigger piece in the next fund.”
Draper says he does admires a structure set up by one contemporary firm – Draper Fisher Jurvetson, which manages a series of small, regionally focused venture capital funds. The firm happens to be run by Tim Draper, Bill's son, and the third generation of a venture capital dynasty. The DFJ funds ‘make their own decisions but share information a lot’, Draper says. “Kind of like we did in the old days.”