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Confessions of a venture capitalist

Longtime investor Alan J. Patricof has an idea about what went wrong with dot-com investing.

    Just what went wrong with dot-com investing? Alan J. Patricof has an idea.

    "Investors behaved in a way that is embarrassing," he noted at Harvard Business School recently.

    As one of the most seasoned investors in the business--with more than 40 years of experience building and managing substantial investments in countless companies, including Apple Computer and America Online--Patricof admitted that he, himself, has taken a couple of wrong turns too. (One that wasn't so minor, he divulged at HBS, was that he allowed the Starbucks phenomenon to pass him by--because, he said, he didn't think New York needed another coffee shop.)

    He also admitted that he and his colleagues at the company he founded in 1969, Patricof & Co. Ventures, which manages $7 billion in 10 countries, was not immune to dot-com fever.

    "Investors started buying eyeballs, clicks, page views--and they forgot about the fact that you have to make money," Patricof said. "As you know today, Amazon is still known for books, Kozmo for videos, and Priceline for airline tickets.

    "People assumed that funding would always be there, at a higher and higher valuation. All of a sudden, the money tree went dry."

    Investors have only themselves to blame, he observed. They failed to recognize, for example, that people don't change habits. People didn't drop what they were doing and rush to the Internet; they didn't stop using the radio, the television and the telephone, he said.

    "We underpriced capital," Patricof charged. "Don't forget that. Underpricing capital means we all paid too much for deals."

    Venture capitalists, for example, invested $10 million in a deal last year that five years ago would have raised a million to do the same activity, he said.

    "We valued it at 50 million because the euphoria, the frenzy that was going on, meant that everybody was afraid they would lose the deal. So too many companies got funded.

    "We made a lot of faulty assumptions," he went on. "We assumed that any head count was a milestone. We hired lots of inexperienced people. Unfortunately, a lot of people like you came out of Harvard Business School, and got a lot of money from a lot of people like me, and you had no experience, or didn't have enough experience, to run a business--certainly not when the business got in trouble.

    "Companies went public way before they should have. And that has been a fundamental change in venture capital."

    Before the boom, said Patricof, venture capitalists would have quietly "nurtured" such companies in their portfolio for four or five years. Many then might have been permitted to die a quiet, dignified death.

    "And all of a sudden, we had companies 12 months old with no gravity, going public and becoming highly visible. People failed to realize the capital intensity of building a business. It takes a lot of money."

    The contortionist activities of the venture capital scene over the past year, Patricof predicted, will have other far-reaching effects on the culture, too--not least on daily attire. "Be prepared for the demise of business casual," he warned.

    So you want to be a venture capitalist?
    Dire recapitulations aside, Patricof found much to praise in future investment possibilities. Consumers will probably appreciate devices that display information yet ring at the same time, he suggested. And his list of investment opportunities to watch for the future was nonetheless long. A few that he mentioned included the Bluetooth wireless standard, broadband, optical networking, biotech and health care, energy, education, and Internet-driven devices and applications.

    Though a vocal supporter of President Clinton, Patricof also speculated that changes in the regulatory environment, which he anticipates under the new Bush administration, will likely spawn a lot of new investment opportunities. Savvy investors would be wise to stand by, he recommended.

    Even so, Patricof sighed, this is a tough time to be a venture capitalist.

    Just having a good instinct is not sufficient to protect one from business disaster, he observed. Venture capitalists require more than good instincts, he said. They need "an endless curiosity," the intellectual drive to constantly ask questions and seek information. They need a willingness to take risks and the guts to "pull the trigger" to make things happen. "It gets scary," he said.

    "Finally," Patricof added, "you need resiliency even on a bad day. You need to be an inherent optimist, because tomorrow will be better."

     
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