Bankrupt entrepreneurs and laid-off dot-commers in Silicon Valley are pointing angry fingers at venture capitalists, whom they blame for taking too many companies public too soon and fueling the great implosion of the tech sector.
A few high-profile VCs are willing to shoulder their portion of the blame, admitting they got caught up in the "gold rush" of low-cost capital and high-return initial public offerings. Some say that the late 1990s will go down as a period of temporary insanity in their niche--a time when virtually any pedigreed MBA student or rookie inventor could get funding after scribbling a business plan on a cocktail napkin.
But the majority of VCs are quick to deflect blame and point fingers elsewhere--at rival firms, entrepreneurs, day traders, analysts and individual investors. Many say they got unintentionally swept up in broader market conditions that rewarded companies based on metrics such as "eyeballs," "stickiness" or market share--regardless of whether the company posted profits or entertained the near-term likelihood of profits.
"If the markets are rewarding companies simply for grabbing market share, you're going to go all out on that field," said Bob Kagle, founder of Menlo Park, Calif.-based Benchmark Capital, who has been a venture capitalist since 1983. "The economic situation (of the late 1990s) attracted a lot of people only interested in the money."
When questioned about their responsibility in the stock market crash and resulting layoffs and cash crunch, many VCs become defensive. If investors were throwing money at you, they ask, wouldn't you take it?
But the average investor could not even begin to answer that question; relatively few Americans ever encounter such windfalls or understand the lottery-like nature of the VC sector as it emerged in the late 1990s. And the venture capitalists' question begs another question: Is the goal of the VC to nurture long-lasting businesses and help entrepreneurs create important products and services--or is it just to pounce on cash as quickly as possible?
There's no question that the economic situation was ripe for VCs to make enormous sums of money in a short period. Historically low interest rates in the United States throughout the late 1990s, combined with an Asian currency crisis and an increasingly dreary economic situation in Europe, inspired investors to throw cash at American ventures such as online pet-food retailers and Internet dry-cleaning services.
Spending other people's money
At the same time, because of banks' willingness to take risks they once would never have considered and an abundance of low-interest loans in the mid-1990s, consumers and businesses spent lavishly--even though the money was not their own.
When those companies' IPOs resulted in stock prices that increased 100 percent, 400 percent or even 600 percent on the first day of trading, the venture capitalists cashed in--and the cost of capital became negative: Investors could make more money by selling shares after companies went public than they put into funding the companies to begin with.
"Money was free, and you just accelerated the business plans by hiring everyone you could and trying to get exit value," said Roland Van der Meer, a partner at Palo Alto, Calif.-based ComVentures, a venture firm specializing in early stage investments with $1.2 billion under management in five funds. "Everything was rushed. Everybody forgot the rules."
Economists and other financial experts outside of the VC community agree that VCs were not entirely to blame for the downturn. Although they were in some ways the most visible and lucky--many of them got out long before the crash--they were part of a larger economic groundswell.
"It's undeniably true that the VCs took too many companies public. It's also undeniably true that too many companies were funded with less basis in reality than in the past," said Russell Roberts, an economist at the Weidenbaum Center on the Economy, Government and Public Policy at Washington University in St. Louis. "But the last time I looked, accepting an investment from a VC was a voluntary thing. In exuberant expansions, there will always be a huge rush of capital. I don't think anyone is culpable."
"We're having a good time!"
Timothy Draper, the third generation of venture capitalists in the Draper family and the founder of Draper Fisher Jurvetson, seemed astonished and angry when a reporter asked about his responsibility in the downfall. Draper said he believes that the VCs and all other parties acted "rationally" in their mad chase for cash. Plus, he noted, being a VC in 1999 "was a lot of fun."
"Why is everyone down in the dumps? This is when we're having a good time!" Draper beamed at a conference last week in Menlo Park, Calif., dubbed "Venture Capital After the Bubble." "The best is yet to come. Now that we're all connected, the next cycle will be faster, bigger and maybe even more wild and hopefully even more fun!"
Draper dismissed the tens of thousands of layoffs in the e-commerce niche as well as the financial losses of millions of investors who put their 401(k) plans in money-losing tech stocks. Thewas down 58 percent in the past year, and the average tech fund slumped a stunning 27.9 percent in February alone, according to Chicago-based fund tracker Morningstar.
The question of whether VCs were responsible for taking too many companies public too quickly is a moot point, Draper said. Also moot, according to Draper, is the question of why the Nasdaq Stock Market became a high-risk VC market for individual investors in the late 1990s. Maybe, Draper said, it should have always been that way.
"I think it's wrong to have an artificial barrier between the private and public companies. Everyone is relatively public. At some point, the investment bankers say, 'OK, you're public enough, it's time to take you out,'" Draper said.
Although many VCs say they are looking forward to the next period of irrational exuberance, most agree that the implosion of the late 1990s bubble has taught them important lessons.
Since the stock market downturn of early 2000, VCs have been creating a sort of triage system to determine which companies they will continue to fund and which they starve out of business. Meanwhile, they have virtually shut off the funding spigot to young entrepreneurs.
Jim Dorrian, general partner of Crosspoint Venture Partners, said the VC industry was partially responsible for the crash. But he never personally intended to pull the wool over investors' eyes by pushing companies bound for bankruptcy, he said. He is now eyeing potential investments with dramatically more scrutiny.
In keeping with the lighthearted tone of the Menlo Park conference, Dorrian referred to a comedy routine that originally appeared in Monty Python's "Flying Circus." The British comedians' "Dead Parrot" sketch hinges on an angry customer who is trying fruitlessly to return a stiff bird to an unsympathetic pet store clerk.
"We are trying to look at this over the long term," Dorrian said. "I don't think the VC community is out there right now selling dead parrots."