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Valley Girl February 26, 2008, 12:01AM EST text size: TT

New York Comes to Silicon Valley

Look to recent funding deals for Ning and Slide to see evidence that Wall Street may be cutting out the middleman—venture capitalists

The relationship between the venture capitalists of Sand Hill Road and the securities firms and power investors of Wall Street has long been a cozy one. VCs hoping for a return on their investments will need banks eventually, while Wall Street needs VCs to nurture the most promising startups until they’re ready to go public.

Or do they?

Lately, some of New York’s biggest players have been cherry-picking the best pre-IPO investments for themselves. Marc Andreessen’s Ning was recently funded by Legg Mason (LM), T. Rowe Price (TROW), and Ziff Brothers Investments for a valuation of more than $200 million. Max Levchin’s Slide got $50 million from Fidelity Investments and T. Rowe Price, conferring a $550 million valuation on the maker of widgets for social networks (BusinessWeek.com, 1/18/08).

Predictably, pundits wrung their hands over sky-high valuations—missing entirely the real cause for alarm among Silicon Valley’s blue-shirt-and-khaki set: Wall Street is putting the squeeze on an already troubled VC community.

The VC Squeeze

If you’ve read anything I’ve written in the past eight years, you know I think the venture capital industry is in a bad way (BusinessWeek.com, 10/3/07). The calamity comes as ballooning global pension funds seeking better-than-broad market returns meet up with venture capitalists eager to fund the next Bill Gates, Steve Jobs, or Mark Zuckerberg (Facebook’s founder)—helping to create an entire asset class out of what probably should have remained a subset of niche investments.

The upshot: Very few firms are making so-called venture-style returns on all that money sloshing around Silicon Valley. Sure, last year’s initial-public-offering and acquisition numbers look good in the aggregate, but when you consider the time and money needed to birth all those “successes,” there were precious few home runs—and a lot of portfolio losses. Outside the handful of VCs that generate 90% of the industry’s returns, a lot of firms are struggling to stay viable.

VC life was already complicated by the so-called angel investors capable of parking big bucks in promising early-stage companies. A lot of hot startups are getting funding early on from angel investors who made their fortunes in the late 1990s. That, along with dramatically lower startup costs, means VCs are forced to buy in when the company is more mature and their funding brings far less ownership, and entrepreneurs are able to retain control in ways rarely seen in the Valley.

And now, thanks to Wall Street, VCs are also getting squeezed at the late-stage end. If even early-stage companies aren’t buying the mantra that VCs add value, provide guidance, etc., then surely a later-stage Web company that’s already reaching a large, valuable audience won’t. And as the Ning and Slide deals show, banks will almost always offer larger valuations—and meddle less.

An Elite Club

For Silicon Valley, the pinch may only worsen, thanks in large part to the efforts of Allen & Co. The New York firm is the expert matchmaker putting together name-brand entrepreneurs with a bank that wants them so bad, it’ll seemingly pay any price. Allen & Co. is heavily relationship-oriented, inviting the cream of the high-tech and media crop to its swanky Sun Valley Media Conference every summer. Where else can a young hotshot founder rub shoulders with Gates or News Corp.’s (NWS) Rupert Murdoch?

But don’t ask the notoriously media-shy Allen & Co. to weigh in on its power-brokering ways. Neither anyone at the firm nor those who do business with Allen & Co. would comment for this column. Last summer I asked a close friend of Allen & Co. if there was any way I could weasel my way into the conference as part of reporting on my book. “Few things in life are impossible, other than walking through a revolving door with skis over your shoulder and this,” I was told. Put another way, I found this July e-mail by searching my inbox for the words “no way in hell.”

Safe Bets

Allen & Co. isn’t entirely a black box, and Silicon Valley does well to understand how it works. While much of chummy Sand Hill Road runs on gut feeling, Allen & Co. relies more on armies of MBAs crunching numbers and running models. The firm does the hard work, finding and courting entrepreneurs, putting them through a due-diligence gauntlet, and then picking up the phone, calling a big institutional investor, and delivering a handsome investment package.

Wall Street institutions love this model for a few reasons. Instead of trying to cram more money into the few truly rock-star venture firms, they can go directly to the hottest companies. If the deal hits, they walk away with a bigger slice of the proceeds even if they have paid a higher valuation, all the while avoiding paying millions of dollars in “management fees” and absorbing losses on the inevitable dogs in a VC’s portfolio. If it misses, big deal. What’s $20 million in a startup compared with $1 billion of Google (GOOG) or Yahoo! (YHOO) stock?

Besides, with markets in turmoil, a modest investment in a private company that won’t go public for a few years represents a relatively safe bet. Even if values decline, the investment won’t have to be marked to market on a quarter-by-quarter basis.

However eager these non-Silicon Valley investors may be to get a slice of Bay Area action, they’re not throwing around money with no strings attached. Wall Street banks aren’t going to be happy with a modest acquisition. If they’re investing at these kinds of valuations, they expect a big swing-for-the-fences IPO at some point. It can take a few years, but there better be a big pot of gold somewhere.

What’s In the Stars?

And not all of these East-meets-West Coast deals are structured the same. Shakier startups too are raising money from institutions, sometimes at terms that are far harsher. I doubt No. 2 widget maker RockYou gets close to the same terms as its larger, star-studded competitor Slide. The companies that can demand the sweetheart deals need to have a great story and some serious star power. Would Ning be worth $250 million without Andreessen? Doubtful.

That means we may not see many more deals like the ones Ning and Slide closed. But the threat these banks pose to investors isn’t about the volume of deals they’re scooping, it’s about seizing the best ones. In the case of Ning, Andreessen took some money from angels, but largely bankrolled the company with $9 million of his own money until he raised money via Allen & Co. VCs never had a chance. And Levchin also funded Slide on his own, in addition to tapping friends and investors from his PayPal days. There was one true venture round for Slide, and even the legendary Vinod Khosla of Khosla Ventures had to fight to get in.

There’s only one thing worse than VCs getting pushed toward later stages of investment—and that’s not getting to invest at all.

Lacy has been a business reporter for 10 years, most recently covering technology for BusinessWeek. Her book, Once You’re Lucky, Twice You’re Good: The Rebirth of Silicon Valley and the Rise of Web 2.0, will be published by Gotham Books in May, 2008. She is also Silicon Valley host of Yahoo Finance’s Tech Ticker.

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At the intersection of business and technology

February 1, 2008, 5:43 pm

Will Microsoft save Silicon Valley from Google?

By Michael V. Copeland and Yi-Wyn Yen

SUNNYVALE, Calif. — There was talk of monopoly in Silicon Valley Friday morning as news of Microsoft’s $45 billion offer for Yahoo spread at Internet speed via e-mail, instant message and mobile phone. But the huge irony is Microsoft’s bid for Yahoo is seen by many here as just what is needed to fend off another monopolist in the making: Google.

“We would prefer to see a healthy Microsoft and Yahoo,” says Geoff Yang, a venture capitalist with Redpoint Ventures and an early investor in Internet-based companies. “But I am starting to get worried about Google’s dominance, and in the absence of three healthy companies, I’ll take two. Competition is good for us, the industry and customers.”

A decade ago, that wouldn’t have been the case as most people in Silicon Valley viewed Bill Gates’ gang as barbarians, taking on, and in most cases crushing, cherished iconic Valley companies like Netscape. No one wants to call it out loud and proud, but the role of aggressor formerly assigned to Microsoft (MSFT) has been taken over by Google’s (GOOG) in the estimation of many of the Valley’s technologists and investors. In the case of Yahoo, Microsoft is more white knight than Visigoth.

By themselves, Yang and others are quick to point out, neither Microsoft nor Yahoo (YHOO) have demonstrated an ability to stop the Google onslaught, but combined they might have the heft to pull it off.

“Putting MSN (Microsoft’s Internet portal) and Yahoo together ought to provide some more scale and more efficiencies so that there is some reasonable competition,” says David Hornik, a venture capitalist with August Capital and another experienced Internet investor. “We could get more of a real marketplace than we have today.”

The hopeful note was also sounded by a number of former Yahoo employees. One of the original Internet companies, Yahoo still boasts the most traffic of any site online, streaming through its portal and various properties. And with additions like Flickr, Zimbra and other Web 2.0 startups, it has kept a strong hand on the content side.

“Yahoo will never catch up with Google in search,” says Paul O’Brien, a six year veteran of Yahoo and the head of marketing at local events search startup Zvents. “They can continue to be a portal, but there is not much room for growth there. But Yahoo is still a sexy company. Combining with Microsoft puts their properties in front of everyone who has a computer. If I were still at Yahoo I would think this is good news, it’s a new opportunity and new blood.”

But feelings were decidedly mixed Friday morning at Yahoo’s Silicon Valley campus in Sunnyvale, Calif. Four hours after the news hit, about a dozen Yahooligans were having coffee and omelettes in the company’s cafeteria and discussing whether Yahoo would accept Microsoft’s bid. Those approached by a Fortune reporter spoke on condition of anonymity.

“This is all anyone’s talking about this morning. But I can’t comment,” said one Yahoo employee, pointing to a glass wall where a group of managers sat. “They’re watching.”

The Microsoft offer follows Tuesday’s announcement that Yahoo would lay off 1,000 workers by mid-February.

Now this. Just how many jobs Microsoft might shed after acquiring Yahoo is a big unknown. Though employees said there had been rumors for some time about a possible Microsoft bid, the timing came as a shock. “I knew the stock price put us in prime selling territory, but I just felt like someone pulled the rug under me,” one Yahooer said.

Some couldn’t be happier as Microsoft’s announcement drove Yahoo’s stock up nearly 50 percent by mid-day. “This is great news, great news,” said one employee who works in accounting. “I’m not worried about my position or finding a job elsewhere, so I’m pretty excited about the stock going up.”

“I’m freaked out,” said another employee who joined the company less than a year ago in a junior marketing position. “I thought it would be cool to work for Microsoft at first, but then I read the letter and it sounded hostile. I’m already worried about the layoffs, and this doesn’t help.”

One worker sighed as she reached for copies of the San Jose Mercury News and the Wall Street Journal. “Just seeing if we’re in the news,” she said. “Ugh.” Behind her, about a half dozen colleagues were at the company’s gym running on treadmills with their eyes glued on CNBC’s updates.

Steve Mitgang, CEO of online video site Veoh, and a former senior vice president at Yahoo in charge of ad products and the creation of the company’s online ad system Panama, is bullish on the combination. “Online advertising is all about being able to understand users in the right context, what they do during their day and their lives,” Mitgang says. “Search is a part of that, but it’s not everything, Google doesn’t have it all. Combining Microsoft and Yahoo gives them the greatest context in the world about what users are interested in. It could be extraordinarily powerful.”

But the big fear among some in the Valley is that Microsoft somehow crushes the thing it most needs in Yahoo, Internet expertise. The smart move, say Valley insiders, is for Microsoft to admit they have failed at the Internet game and let Yahoo become their online presence. “If I were Microsoft I would look to Yahoo to be the lead in figuring out the digital future,” says Hornik. “Not the other way around.”

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