Notes of Note from John F. Ince

Archive for December, 2009

A quantum leap forward in our thinking about money is upon us.

From the Introduction to The Money Question:

As our economic and environmental crises intensify, a new wave of thinkers and social entrepreneurs are putting forth business models with the power to transform the systems that support us.  Pieces of a comprehensive solution that had been disjointed and disorganized are coming together as building blocks for a sustainable solution to our financial, ecological and social crisis.  These innovators are not your typical blue suits, nor are they a rag tag collection of fluffy thinking dreamers. They represent a full spectrum from the worlds of finance, environmentalism, non profit, philanthropy and public policy. They include bankers, foundations, activists, new money, venture capitalists, financial advisors as well and a whole new breed of social entrepreneurs who are changing the world with business models that integrate financial return with social contribution and ecology. Their discussions are rooted in rigorous analysis and hard metrics.  The consensus is clear: the old models of capitalism are coming under serious stress, and the time is ripe for bold new thinking that integrates a more holistic view of what constitutes true economic value and sound investment strategy.

via John Ince’s Blog – Vox.

David Paul: With Wall Street Shorting the Dollar, It is Time for Congress to Pursue Fundamental Change

This all done with the implicit guarantee of taxpayer money ….

And the carry trade will work out fine. Until it doesn’t. Then the trade will unwind quickly, and those who do not get out in time will get hurt badly.

But the banks are not worried. If the unwinding of what NYU economist Nouriel Roubini has labeled “the mother of all carry trades” takes a bank or two down with it, everything will be all right. Because the bank deposits are still insured, and we now know to an absolute certainty that if one of the elite institutions fails, we will bail it out. Again.

It is time that we come to grips with the depravity of the current situation, and potential damage that continuing down this path may yet do to the financial system and to our economy.

Our commercial banks are not, and should not be, hedge funds. U.S. dollar carry trades and writing credit default swaps are not core commercial banking functions. They are not necessary to the efficient functioning of our financial system.

The U.S. dollar carry trade is destructive to our currency, and is creating asset bubbles across the world, as leverage is transferred from our markets into others. For their part, credit default swaps serve no useful purpose in proportion to the systemic risks they create.

It is time to go back to basics. Commercial banks provide essential services in our economy. They enable the Fed to control the distribution and pricing of capital to the productive sectors of the economy. They provide secure depositary and asset management services.

Unfortunately, pending Congressional legislation has done nothing to address the central risks that the new financial landscape presents to our economy.

via David Paul: With Wall Street Shorting the Dollar, It is Time for Congress to Pursue Fundamental Change.

Podcast with Sandy Miller of IVP – Part I

Podcast with Sandy Miller, General Partner with Institutional Venture Partners – Part I


John Ince Interviews Bill Hambrecht, Founder of WR Hambrecht and Hambrecht and Quist

John Ince Interviews Bill Hambrecht, Founder of WR Hambrecht and Hambrecht and Quist

Bill Hambrecht, 64, is Chairman and CEO of WR Hambrecht + Co, a financial services firm headquartered in San Francisco that he founded in January 1998.   Bill resigned as Chairman of Hambrecht & Quist in December 1997, the investment banking firm he co-founded with the late George Quist in 1968.   WR Hambrecht + Co leverages the internet and the auction process to bring transparency to capital formation and securities exchange processes.  The firm’s earliest and best-known innovation is OpenIPO, an auction-based model for initial public offerings.  WRH+Co is expanding the use of the auction to high-grade corporate debt offerings and other capital markets. He currently serves as a director for numerous private and public companies including KQED, Inc., San Francisco’s public radio and television station and Beacon Education Management, which manages charter schools.  Mr. Hambrecht graduated from Princeton University.

Ince: What was your original business model?

Hambrecht: The original business model was to see if we could put together the breadth and power of the web with an auction process.  The reason I thought we needed both was that the web was obviously a very efficient, cheap and quick way to communicate with a large group of people.  It was obvious that this could be a great mechanism for distributing securities to affinity groups or retail customers.   But I also felt that there was no way this would happen unless you had another pricing mechanism that took away preferential distribution.   As long as there was preferential distribution, the IPOs or any attractive new issue merchandise would flow to the best brokerage customers.  That’s the way the business is driven. So I felt that we had to do both.  I knew that the really difficult thing would be to get a different pricing mechanism in a market that was used to negotiated pricing.

Ince: How has that business model stacked up against reality?  Do you still feel it’s a valid model?

Hambrecht: Oh yes.  Definitely.  As a matter of fact, I think it’s almost a classic destructive technology in Clay Christensen’s (Harvard Business School Professor and WR Hambrecht Board Member)  model.  Effectively what’s happened is that we’ve done four IPOs and one debt auction and we have a number coming along.  It been greeted with skepticism and a lot of competitive heat against it, because it’s clearly going to change the economics that accrue to the managing underwriter in a traditional deal.  It seems to me that the competition has reacted just as Clay Christensen’s model suggest they would.  They added more services, more analysts and more functionality in an effort to stave off what is inherently a more efficient and cheaper process.

Ince: How will it change the underlying economics?

Hambrecht: In two ways.  First of all, there is really no justification today for the traditional 7% spread for an IPO.  It was a historical spread that used to be paid when you really needed salesman to sell a new issue.   But in the last 10 years new issues are priced so much below the market that they get allocated, not sold.  And they get allocated to the best commission clients.  So the second form of profitability, which not obvious to everybody, but is very much there, is the tremendous reciprocal flow of commission business to the underwriter, who delivers a guaranteed profit to the institutions.

Ince: How does that work?

Hambrecht: No one will admit to it, but effectively at some point or another an underwriter, salesmen or somebody will count up how much guaranteed profit they’ve given to an institution and will want a certain flow of commission business back.  My own gut tells me that the commission kickback to the investment bank is about 20%.

Ince: Can you give an example of this?

Hambrecht: If you take a 1999 average IPO.  It was a $50 million deal. The underwriter’s commission was 7%.  The stock price doubled and it basically created $50 million in guaranteed profit for the institutional investor that was in on the initial stock allocation.  The managing underwriter, who determines where about 90% of that stock goes into the institutional pie, will probably get about $10 of commission flow back.

Ince: The skeptics that you refer to suggest that your Dutch auction process is insufficiently sensitive to the aftermarket for the stock.  Do you agree?

Hambrecht: It depends what you want out of the aftermarket.  If you are distributing an offering where you are implying to the buyer that it going to have a big premium over the offering price, then yeah you want to set it up to create as much irrational demand in the marketplace as you can.  And you do that by creating this image of great demand and very little supply.  You do it subtly, but you do it.  It goes out and jumps dramatically on the first day.  This gets in all the newspapers and everybody says, “Gee this is a great deal.” To maintain that price, it has to bring in a lot of interest from  day traders and aggressive trading accounts, because they think this is something very hot.  The problem with that is that it doesn’t last.  This is what gives the big institutions an opportunity to flip the stock and have a guaranteed profit.

Ince: How will the Dutch auction change all that?

Hambrecht: What we try to do is have an aftermarket that first of all, the foundation is set by a group of buyers that bid for the stock they own.  In other words, this group of people in effect have helped set the price.  There is no expectation of a big runup on the first day.  So instead of this huge of amount of trading that you get on the first, second or third day, there is very little trading.  Because there is really very little need to turn it over.  We think that our system finds people that really want to own the stock as an investment rather than a trading vehicle.

Ince: So which system has a better pricing mechanism.

Hambrecht: An auction delivers a price that is a lot closer to the real market demand, than an artificially negotiated price that is really negotiated to create this big runoff and this big emotional frothy aftermarket.

Ince: In doing this, are you alienating some of the “loyal” institutional investors?

Hambrecht: Maybe, but that should have nothing to do with the placement of the underwriting stock.  The company pays you a spread to place the stock with long term shareholders.   Whether the underwriter gets a kickback of commissions or not, should have nothing to do with where that stock goes.  If you’re doing the job that you get paid to do, you should place it with the best possible long term buyer.  What has happened, because of the guaranteed profit in this business,  95% of the stock gets turned over the first day.  So the company isn’t getting what it’s paying for.  The underwriter is getting a lot more profit than even the company realizes, because it’s done in this reciprocity rather than in an open spread.

Ince: But the underwriters suggest that their financial incentive is to price the stock as high as possible.  Is that true?

Hambrecht: No, the underwriter’s real incentive is to price it as low as they can, because the indirect payment comes from the big premium that is placed on the stock in the aftermarket.  Our system does get them the highest possible price commensurate with the market level.  In other words, it should be true demand, not emotional demand.

Ince: So what is the ultimate potential of the Dutch auction?  Others suggest that it at best will be a niche market?  Do you think it has larger potential than that?

Hambrecht: On August 15, we our first debt offering using the Dutch Auction.  It was a $300 million debt offering for Dow.  It went extraordinarily well.  We think that Dow ended up with a price that was about as close to the true market level as you could come.  It’s trading now about one basis point away from where it came out.  It also got a much bigger mix if buyers than you normally get in a debt offering.  We think it will spread very rapidly in that market.

Ince: Do you see the other investment banks picking up on this?

Hambrecht: Well, they’re going to have to respond in some way.  It’s created a lot of interest.

John Ince Interviews Joe Shell, Formerly Head of Merrill Lynch Investment Banking

John Ince Interviews Joe Shell, Head of Merrill Lynch Investment Banking in 2000

Note:  This interview was conducted in 2000 while Ince was with Upside Magazine

Interviewed by  John F. Ince

Joe Schell joined Merrill Lynch in February of this year as head of global technology investment banking. Prior to that, Schell headed investment banking at Montgomery Securities for approximately 15 years. Subsequently, he was head of investment banking at Bank of America after its merger with Montgomery in 1998. At Merrill Lynch he has expanded the global investment banking group from 80 to 175 professionals with a goal of making Merrill Lynch “the premier technology investment bank.”

Upside: What do you make of the recent trend towards commercial banks acquiring investment banks and how does this change the underlying competitive dynamics of investment banking?

Schell: Global reach is very important in today’s world. Everybody is getting bigger.  This makes for fewer, but stronger competitors.  Small firms can appear to be more facile and able to react more quickly, but, particularly in the technology sector, companies need firms with global capabilities almost immediately.  They’re picking firms to do their first financings whether they be private financings, IPOs or M&A transactions earlier in their lifecycle,  firms that they can stay with in the long term.  The underlying message to take from DLJ-First Boston and Morgan-Chase and all the recent mergers is that scale, and having capability in all relevant areas, particularly the high margin areas like investment banking is extremely important. They’re trying to match the global scale that we already have.

Upside: How much of this is the result of regulatory changes and how much is other factors.

Regulatory changes allowed it, but it was not the catalyst.  The market was the catalyst.

Upside:  How is technology changing investment banking.  The conventional wisdom of investment banking is that it is a relationship driven business.  Are the potential efficiencies that grow out of the Internet as applicable to investment banking as they are to some of these other industries that are being transformed?

Schell: I agree that investment banking continues to be a relationship driven business as opposed to a transaction driven business.  All of us invest a lot of time and energy in building relationships. Technology is affecting some parts of the underwriting and distribution process, but I don’t believe it will displace the relationship advisory side of investment banking.  On the brokerage side, I just don’t see that all of a sudden, because of the power of the Internet, a brokerage client is going to be perfectly happy in a relationship where he never meets a broker or talks to or sees the research from a broker.   There is certainly a place in our economy for online brokerage, but I just don’t see it overwhelming the full service side of the business.   It’s not black or white.  It’s not one replacing the other. The online brokerage business is expanding rapidly, and in fact we have one of the best offering available.  But at the same time there are still a lot of smart  people who are willing to pay for the extra services you get from a full service firm. They will co-exist happily.  Depending on marketplace at any give time one will seem to have momentum versus the other.

Upside: So what are firms like Merrill doing to compete in this new economy?

Schell: Most all the older firms that have done business the full service way, now have online initiatives that have become part of their offerings.  I don’t think there is any credence to the thought that we’re going to be marginalized.  We will be more and more competitive thanks to some of the smaller younger companies that are showing new ways of doing things.

Upside: What are the key success factors in investment banking today?

Schell: Brand will always  be important given that it continues to represent what a firm stands for.  In the case of Merrill Lynch, our brand is a global firm, the symbol of our brand is the bull and that represents our positive outlook.  We do our best job when the markets are difficult and when there is the need to market more broadly.  Also important is the ability to market broadly.  In a service oriented business like this, a firms’ ability to prove themselves in volatile times like this is critical.  That means having the resources, the capital, the research, and good people and being able coordinate those resources.

Upside:  Since Netscape went public, we’ve had firms going public at a much earlier stage in their lifecycle.  Has the volatility of the marketplace become institutionalized by this trend toward earlier stage IPOs?

Schell: To some extent yes.  The public markets in the last couple of years have been accommodating to companies that were not as mature or well tested as they used to be.  You’re like likely to have issues that come in out in first couple of quarters as public companies that are disquieting to the market.  We sell public stock, particularly in the tech world, on the basis of promises or expectations of future performance,  more than on past performance.  So if there’s any hiccup or wrinkle in that performance, it gets magnified greatly because of the dependency the market had in the first place on buying these companies on the basis of expected performance.  Sometimes valuations got ahead of where the fundamentals were.  All of sudden the individual investor has awakened to the fact that this is not a no risk business.

Upside: Let’s focus on pricing for a moment. Do the open IPO and Dutch auction being tried by WR Hambrecht make sense, and do you think it will ever catch on in a major way?

Schell: The Dutch auction approach has utility and merit when there is a very sophisticated market and you’re trying to find the buyers who are willing to pay the greatest price.  But, I don’t think it has applicability in most technology IPOs.  I don’t think that the individual investors or the more aggressive hedge funds that are willing to be the highest priced buyers in IPOs, create a very stable aftermarket.

Upside: Can you expand on that?

Schell: When we do a transaction, we’re not only trying to accomplish the best price for our client.  Many times the best firms know that they could sell the issue at a higher price, but they feel that the lower price would accomplish the firms objectives of a fair price for the stock, but also accomplishes the other side of having investor purchase the stock and know that it’s a good investment not just for a day or two, but for a longer term.  That creates the stable aftermarket, hopefully a gradually rising aftermarket.  The company then has access to the public markets again, and it has served the best interests of all parties.   In a Dutch auction, you sell securities to the highest bidder and that is totally inconsistent with a good aftermarket because you wipe out all the upside potential. The Dutch auction process doesn’t have the sensitivity to the aftermarket dynamics that we have when we do it the regular way.  You’re making a long term mistake for the company and it will be born out pretty quickly.

Upside:  But what 1999 where we saw the huge jumps in stock price, and the issuing firm lost out on the fundraising potential when the price was priced so low. What do you say to the firms that feel that because the initial price was price too low, money was left on the table?

Schell: I’m not aware of very many companies who feel betrayed by their underwriter.  There is so much input to a company during the course of selecting investment bankers.  They’re face to face with the investment bankers during the roadshow.  They are given a very thorough education about how stocks are valued in public markets.  For the most part, all the people who are involved with making pricing judgements,  own significant portions of the stock and they love to see the stock jump from 20 to 80.  Most people understand that underwriters make more money if we sell it higher.  But we have to find the highest price consistent with the job we set out to do: having a successful public launch and strong aftermarket.  We have audiences on both ends of the process and we’re trying to find that perfect price which maximize values to the sellers of the stock and also creates the best opportunity for investors down the road.

John Ince Interviews Thomas Weisel, Founder of Montgomery Securities and Thomas Weisel Partners

John Ince Interviews with Thomas Weisel, Founder of Montgomery Securities and Thomas Weisel Partners

Introduction: Tom Weisel, graduated from Stanford University in 1963 Harvard Business School in 1966,  has now been in the investment banking industry for 35 years.  He was the founder of Montgomery Securities and guided the firm to national stature, particularly in the high tech area.  Twelve months after Montgomery was acquired by Bank of America in 1997, Weisel left to start Thomas Weisel Partners.  Barely two years later, the Thomas Weisel Partners website boasts that they are the are the fastest financial services startup in history.

Ince: So you’ve managed to to get off to a fast start.  Can you compete with the big boys in an industry where many of them are getting even bigger and starting to offer a one stop shop for financial services?

Weisel: By the way, we could have made that statement even bolder and said we are the fastest startup in history, not just the fastest financial services startup.  To my knowledge no other startup has attained revenues of $186 million the first year and $500 million in the second, as we have done. Obviously I think we can compete with the big boys.  Yes, you’ve got some of the finest financial institutions in the world merging and clearly their strategy is to build global institutions, with a breadth of products to retain and grow their client base.   But I personally think that many of these mergers are not going to work.    The more thoughtful growing corporations in America aren’t interested in a one stop shop.  Instead they’re interested in two things the big firms are not delivering.  They’re interest in quality ideas and bulge bracket execution capability?

Ince: What do you mean by bulge bracket?

Weisel: Bulge bracket means top six investment banking operations in the United States. This is not just my opinion. The world defines bulge bracket that way to include Morgan, Goldman, Merrill.  The next three kind of change but today it includes Solomon, First Boston, and then the sixth is open to question right now, because of all the mergers, the definition of who is in the bulge bracket is changing as we speak.

Ince: How is the trend toward mergers and acquisitions changing the underlying competitive dynamics of investment banking?

Weisel: Basically, it’s eliminating competitors.  It allows firms like ours to grow with less competition.  You look at who the top 10 or 20 competitors were ten years ago and you’ve just eliminated a lot of them.

Ince: Since the Netscape IPO companies have been going public at a much earlier stage in their lifecycle, and often investors know little about these companies at the time of their IPO.  What’s causing all this and are the public markets performing a venture capital function?

Weisel: In 1999 and the first quarter of 2000,  many companies with dubious business plans were able to raise venture capital money in the public marketplace.   It allowed companies to get capital way earlier than they should have.   There were a lot of things contributing to that.  During  that period,  online retail assets went from $300 billion to a trillion.  Then you had the trend towards momentum investing in the institutional world. This was exasperated this by the incredible of Tsunami of capital that flowed for the first time into the public markets from the online retail investor.  They bid up indiscriminately the values of anything in the retail world that was broadly defined in the Internet space whether that be commerce, bandwidth or infrastructure.   Many companies went public that should have stayed private, and it lead to the volatility in the stock market.  These were not real intelligent investors.  These were “mo” investors (Momentum investors).

Ince: Has this trend started to institutionalize volatility into the stock market?

Weisel: No,  All that came unwound in April and May of 2000.  Today companies have to have a lot more substance in terms of a verification of a business model and verification of products before they can go public now versus that 15 month window.

Ince: So has the March/April shakeout changed the investment tenor?

Weisel: I think so.  But  on the other hand when you have the kind of multiples on earnings and revenues that you have in some areas of the marketplace, that is going to create tremendous volatility.  A combination of the online retail investor going from a very small to a large part of the marketplace, and the ownership of these companies,  along with very high valuations of these companies–that is a cocktail for volatility–the likes of which the capital markets have never experienced.

Ince: How does one navigate through such volatility?

Weisel: Focus and deep domain expertise is a critical valued added component.  The marketplace is not one size fits all. The nuances between companies even in the same space have never been greater.  Corporations need to be very very smart about when and how they access capital markets to their advantage.  They’ve got to make volatility their friend and not their enemy.

Ince: Will we continue to see these high multiples?

Weisel: It depends on the industry and the company.  In the main companies, are valued on the basis of their potential in the marketplace, and many of these marketplaces are just so new that people just don’t know how big it is.  Is it $10 billion, $30 billion.  That’s the function of a firm like ourselves, to bring some context.

Ince: What do you think about the so called “new”  techniques of evaluating these companies?

Weisel: Many people are justifying ridiculously high prices, by using supposedly new metrics. But the marketplace is not really changing the method of valuation.   If an investor falls into that trap, he’s going to lose a lot of money.   This all about marketplace

Ince: Let’s talk for a moment about the pricing issue.  Do you think the Dutch auction has merit as a pricing technique?  Will it ever catch on in a major way?

Weisel: The Dutch auction has been used for decades in pricing secondary auctions.  It’s a smart way of raising money for a company that is already public.  It makes no sense for IPOs.  It was a failed concept from the very beginning.  What company wants to price their IPO at the maximum high they possible can get because of supply and demand?  That makes absolutely no sense, because you are doomed to failure from the very beginning.  The stock has no place but down to go.  You’ve got nothing but upset shareholders.  You’ve got future options and employees that are under water.  It’s a virtual cycle.

Ince: But doesn’t it maximize the amount of money a company raises in an IPO?

Weisel: It maximizes the price, but the capital raising function is a two way street.  Both the issuer and the buyer need to win.  You’ve got to leave something on the table–future profitability for the buyer as well as the seller.  By the way,  the owner of companies doing IPOs are not selling.  They need to maintain and increase the price over the next year or two so they can exit and realize their investment.  So if they’ve ???? top ticked??? the stock price in raising capital, all of which goes in the company and not to them, that’s a failed strategy.  So what you want to do is price things where it’s most probably going to sell given no change in the environment or comparable company’s stock prices.  If you’re going to sell something at 50% or 100% higher than it would be rationally compared to, just because of a supply – demand imbalance, then you created in the offering, that doesn’t make a lot of sense and it’s a disaster waiting to happen.

Ince: Why?

Weisel: Because rational investors will eventually become rational and the stock price ought to come down to where that company should be valued relative to other comparable companies.  That’s essentially what most investment banks do.  They look at what other comparable companies are valued at and make a judgement based on the differences between the market opportunities, the product the management team and then attempt to price the company relative to those ideas.

Note:  This interview was originally published in Upside Magazine in 2000

Investment Banking – The Art and the Science

Investment Banking – The Art and the Science

by  John F. Ince

For eons the business of investment banking has been considered equal parts art and science.  It is a relationship driven business where the feel for the market at a particular moment can be a key competitive advantage for a firm.  And yet all around the new economy, technology is taking much of the art and feel out of business transactions.  The question remains:  how much longer can investment banking remain a tradition-bound industry where personal relationships and long standing practices are the driving force in most deals?

For the moment investment banking is basking in the afterglow of rapidly increasing revenues and profitability?  What’s giving fuel to all that growth?  First there has been the astounding increase in the availability of venture capital.  The maturation of the venture capital industry has provided a steady flow of IPOs to the industry.  According to Thomas Weisel (See Sidebar) of Thomas Weisel Partners,, “80% of venture backed companies get sold and never go public.  20% go public.  You’ve gone from roughly 25% of the IPO market being venture backed companies to over 65%.  And obviously the result has been a tremendous acceleration of the dollar volume of the IPO market.”

With accelerated consolidation in all sectors of the economy, there has been a dramatic increase in size and flow of M & A activity,  and therefore a dramatic increase in fee income.  The rise in the stock market has generated an ever increasing trading volume.  Last year, according to Weisel, $180 billion of equity was raised in the public area compared to $100 billion the year before.

The net net has been a dramatic growth in the profitability and size of the investment banking industry.  According to Weisel,  if one include revenues from institutional brokerage, M & A and equity,  the industry has been growing at 35% compounded rate for the last decade.  Weisel estimates that that marketplace has grown from $17 billion in 1995 to $40 billion in 2000.

All this is taking place against the backdrop of regulatory changes.   Last year, Washington opened up the floodgates of change with the partial repeal of Glass Steagell, which since the Depression era has legislated the separation of commercial bank, investment banks and insurance companies.  Quickly cam wave after wave of merger and acquisition. Each commercial bank felt they needed a boutique house to fill out their offerings.  Fleet picked up Robertson Stephens, which had been was bought in  1997 by BankAmerica.  B of A sold it the next year to BankBoston, which dropped BancBoston from its name after its parent merged with the increasing voracious FleetBoston Financial. NationsBank then swallowed up Bank of America, which had previously swallowed Montgomery Securities.

Chase Manhattan, not quite satisfied with their acquisition of  Hambrecht and Quist, made the big splash in mid-September with a purchase of the venerable house of Morgan for $35.2 billion or $195 share.  That transaction united two to the most venerable banks each with  rich legacies, but the synergies remain unclear. Having already acquired Chemical Bank and Manufacturers Hanover, Chase is attempting to position, the newly christened, J.P. Morgan Chase as a one stop shop that can compete in both commercial and investment banking.  That deal comes on the heels of two other major acquisitions of investment banks by commercial banks.  UBS, the giant Swiss bank paid $12 billion to buy Paine Webber early in 2000, and in August 2000, Credit Suisse ponied up $12.8 billion to buy Donaldson, Lufkin & Jenrette.

Will all these strategic moves pay off?  Not everybody thinks so.  Says Thom Weisel, “With the JP Morgan – Chase deal and the DLJ deal, there’s a tremendous amount of overlap.  It represents a thought process that is, quite frankly, historical–the global footprint, one stop shop, broader product base, bigger balance sheet – compete on the basis of capital.  These larger firms have gotten so large that they suck the best quality people into management.  Then they Peter Principle them up, so that they’re not really dealing with clients any more, and the people under them are just kids.”

For the better part of the 1990’s, J.P. Morgan had been attempting to transform itself from a blue-chip commercial bank into a investment banking powerhouse.  The Chase-Morgan deal underscores the desire of the commercial banks to move into higher margin business.  Says Joe Schell (See Sidebar) head of the Global Technology Investment Banking Group at Merrill Lynch, “Commercial banks have wanted to get into high margin businesses like investment banking for years. They hadn’t been successful getting into those businesses on their own so now they’re doing it by acquisition.”

Then there are the pioneer firms like Wit Soundview and WR Hambrecht + Co, who are betting that the changes all around the new economy are so fundamental, that it is simply a matter of time until investment banking is also transformed.  The Internet has opened up the possibility of new and potentially revolutionary delivery mechanisms for stock in IPOs.    According to Chris Mulligan, Managing Director of Wit, “Our mandate is to revolutionize the capital raising process. What does that mean?  It means we facilitate the dissemination of critical information, aggregate all demand,  allocate securities in a smarter fashion and insure better price transparency.”

While the pioneer firms have gained a lot of publicity, their volume of offerings and allocations has been small.  Although Wit has participated in 130 offering in 1999 and 119 offerings as of September 2000, they have managed only a handful. So far only four companies have used WR Hambrecht’s Dutch Auction (See sidebar).  One possible explanation for reluctance of issuing companies to let startups like Wit and WR Hambrecht manage their offerings is due in large part to what Bill Hambrecht calls the “Cathedral Effect”.  Says Hambrecht, “Issuing stock is a major event in the history of a company, not unlike a marriage.  For economic reasons the father of the bride tries to convince everyone that the Justice of the Peace makes the most sense.  The bride however usually wants to be married in the cathedral.”

The Internet has also lowered the barriers to entry in the financial services marketplace. Both financial and nonfinancial firms have been able to role out products and participate in new marketplaces. The net result is that the financial landscapes has becoming much more competitive.  According to Adam Holt, analyst with Chase H & Q, “What you have is traditional financial institutions trying to find ways to maintain customer bases, and remain competitive in a rapidly changing environment.” Companies like e-loan,, NextCard are moving into lending spaces that had traditionally been the exclusive empire of the financial institutions.  Then you have companies like E-trade and Ameritrade moving into the brokerage industry,  distintermediating more traditional financial service firms.  At the same time you have new breed of ground up banks like Wingspan or Netbank.

The so called ‘bulge bracket” firms frequently use rhetoric that seems dismissive of potential threats to their hegemony from the upstarts, but their actions suggest that they take the larger threat posed by technological change quite seriously.  If technology is the dimension on which investment banks will compete, Goldman Sachs, for one, intends to be well positioned to maintain their leadership position. Goldman has earned it’s stripes over the years taking some of the largest technology companies public including Microsoft and Yahoo.   Says, Steven Mnuchin, Co-Head of the Technology Operating Committee and Global Head of e-Commerce at Goldman Sachs, “Technology is having a dramatic impact on all areas of the firm. Not only do we work with technology-focused clients in our banking and investment banking practices, but we have also made  a major internal commitment in this area as well.”

Indeed, Goldman now has over 3500 full time professionals dedicated to internal technology in areas like electronic trading, risk management systems, infrastructure, clearance businesses, operations and modeling.  In this fiscal year they will be spending $1.5 billion on internal technology.  On September 11 2000, Goldman further emphasized their commitment to technological leadership with their acquisition Spear, Leeds & Kellogg L.P. (SLK) for $6.5 billion.  This deal  positions Goldman firmly at the center of price discovery.  It also puts Goldman Sachs at the forefront of advanced technology, specifically in the development and application of sophisticated trading, execution and clearing technology.  The SLK deal comes on the heels of their 1999 purchase  of  Hull, the largest electronic trader of options in the United States,  for $500 million.  Hull had developed a sophisticated platform to find the best price for options. Goldman has also hedged its bets with 15% stake in Wit Soundview. Stating the obvious,  Mnuchin says,  “We see technology as critical to our future success.”

None of these strategic moves would have been possible without Goldman’s 1999 IPO with netted them in excess of $5 billion.  With investment banking operating on such high margins, can  others be far behind with their IPOs?  Fleet Boston Financial Corp is rumored to be considering spinning off it’s subsidiary investment banking house, Robertson Stephens, in an IPO.  These moves are but one more acknowledgement of the extraordinary values being created by investment banks today.

Merrill Lynch has also made a major commitment to global investment banking bringing in industry heavyweight, Joe Schell, formerly with Montgomery Securities, and Banc of America Securities to shore up their technology capabilities.  Schell wasted not time, more than doubling the size of the technology investment banking group, from 80-170 within his first 9 months on the job.  He expects to add another 70 people within the next year.

New ideas often take hold slowly, especially in industries as tradition bound as investment banking.  It may be a stretch to characterize investment banking today as an industry at the crossroads, but it clearly exhibits many of the symptoms of one entering the nascent stages of transformation.  And much of that transformation is due to technology. Given the fundamental nature of the transformation that is sweeping through other sectors of economy, we can soon expect investment banking to undergo a more radical transformation that it has seen in decades?

Scrutinizing Seven Popular Myths About Venture Capitalists

Scrutinizing Seven Popular Myths About VCs

by John F. Ince

As the VC industry picks itself up and dusts itself off it’s a good moment to take a critical look at the popular myths that surround the industry in general.  Here is my analysis of seven popular VC myths:

Myth Number 1:  VCs are motivated primarily by greed.

John Ince’s Analysis: If greed is the same thing as the desire to maximize return on investments, than this not a myth.  VCs take their fiduciary responsibility to their limited partners very seriously, because their LPs give them the opportunity to play this game. To the extent that this is a game, VCs clearly want to win. Their competitive juices flow and they hate it when one of their competitors has scooped up a great deal that they wanted.   A lot of VCs keep track of their successes, by the amount of money they’ve made.  That is their way of keeping score.

But to suggest that VCs are primarily self-serving, also hits wide of the mark,  for their motivations are complex. The best VCs also a great deal of pride  in what they do to helping entrepreneurs nurture their visions.  They also derive satisfaction by playing a role in catalyzing the formation of the high tech industry.

So, if VCs are greedy, it is not  unlike the vast majority of people who go into business.  Venture capitalists are in the final analysis, capitalists.   What particularly irks some entrepreneurs  isn’t that VCs are greedy, but that they have acquired so much leverage, and as a result, seem to be able to bend circumstances so easily to their advantage.

Myth Number 2: VCs are now investing so much capital that they are stretched too thin and they cannot possibly give individual companies the assistance they need and deserve.

John Ince’s Analysis: During the crazy days of the dotcom bubble, this was becoming true.  But the the best firms have recognized the downside here, and are moving to better leverage the time of their GPs by providing them with the resources they need to better assist portfolio companies. Also, as VCs steer more of their capital to existing portfolio companies, the pressure to sit on more boards is diminished.

Myth Number 3:  VC are our societies primary catalysts for the development of high tech and emerging growth industries.

John Ince’s Analysis:  This is now almost boilerplate in VC public policy pronouncements.  Clearly this is more than rhetoric.  But to suggest that VCs are the primary catalysts is to diminish to the role of entrepreneurs.    The high tech boom that has propelled the US economy for the last decade, would never have happened without the growth and maturation of the venture capital industry, but VCs would be nothing without the entrepreneurs who make them what they are.

Myth Number 4:  VCs have been exploiting the recent market downturn to extract a few extra pounds of flesh from the entrepreneurs they purport to support.

John Ince’s Analysis: Valuations are a function of the marketplace. Any value set is a function of negotiation.  Let’s face it,  venture capitalists try set the valuation as low as possible, and the entrepreneur tries to do the opposite.    In this environment, even though there is a lot of capital, most of it being steered to keep existing companies alive, so there is less available for new companies.  That works in favor of the venture capitalist in the negotiation process. According to Vivek Wadhwa, CEO of Relativity Technologies based in Cary, NC “If you speak to a VC, they have all these formulas to come up with a valuation for a company.  But in reality, it’s a game to see what they can get away with.  They’re trying to pay the least money to get the maximum ownership of a company.”  Many entrepreneurs feel they are getting taken to the cleaners with lower valuations, sometimes with anti-dilution clauses kicking in followup rounds of financing. Under these clauses,  early round investors are entitled to increased shares, when a company’s valuation is lower in later rounds of financing,   even if the material facts surrounding their operation improve.  Yes, to some entrepreneurs, this appears to be exploitation, but let’s face it: market valuations 18 months ago were vastly inflated, and the reality of the current market is simply a reflection of that fact.   In the final analysis, VCs still want the dynamic of an entrepreneurs motivational scheme to remain in force.  Remember, VCs are also suffering in this climate, and they have their fiduciary responsibility to investors.

Myth Number 5:  VCs are hugely overpaid for what they do.

John Ince’s Analysis: VC are paid well, very well indeed, but what they do is hugely valuable.   Sure, some VCs have hit home runs that put them in upper stratosphere of income brackets.  But not unlike the lottery, those few cases exist as incentive for the rest of the industry to assume often unreasonable risks, largely on a hunch.   For 20 years, the VC model has been simple.  The “VC’s law of threes” holds that one of three VCs investments will fail, the second will be like watching paint dry and the third be a winner.  The hurdle VCs set varies depending on the environment.  Some require a return as high as 65-70%.  Others are lower. Says, Rick Frisbie of Battery Ventures, “We set a hurdle of a 40% weighted return for each deal, where the average of four different scenarios–best case, optimistic, conservative and downside must produce a 40% return in discounted cash flow on our investments.”  Most top tier VCs want their investment to operate in a market large enough to justify a half billion market cap within the startups gestation period. That gestation period in 1990 was about 6-7 years, but it has been telescoped down to two years.  It will probably settle back somewhere in the range of three to five years.

If one questions the value VCs bring to the entrepreneurial equation, one need go no farther than eBay example.  Despite 40% growth quarter after quarter, eBay’s founding entrepreneurs Pierre Omidyar and Jeff Skoll, couldn’t recruit the sort of CEO they needed to run the company. That’s what lead them to Benchmark Capital in 1997.  According to Bob Kagle, General Partner at Benchmark, “At the time Pierre Omidyar, approached us, his company was not only profitable, but cash flow positive.  So he didn’t really need money.  In fact the $3 million that we invested directly in the company, went into the bank and was never touched.  But Pierre felt a professional venture capitalist could be a constructive influence in helping to build the company.  Specifically, Pierre was mature and enlightened with regard to what it takes to build of significant company in terms of experienced and capable executive talent.” With the imprimatur of a top tier venture capital firm, eBay flourished, and none of eBays entrepreneurs today would question the value of Benchmark’s contribution.

Myth Number Six:  With the explosive growth in the industry, an unsavory new breed of VC has begun to infiltrate the industry.

John Ince’s Analysis: This is indeed a myth.  In any industry with the sort of growth we’ve seen in venture capital, there will be some mercenaries–people who enter primarily to get rich quick. But to raise the sort of capital needed to survive in this industry there is a lot of investor scrutiny.  The level of scrutiny can only increase with the recent market corrections.  Those few newer VCs who have lower ethical standards, won’t be VCs for long.

Myth Number Seven:  VCs are risk takers.

John Ince’s Analysis: In a professional sense, VCs take huge risks in their portfolio companies.  But personally VCs are not risk takers.  While some VCs invest their own money in their funds and other investments, the vast majority of what they invest is other people’s money.  Their management fees, ranging from 2-3% of the capital under management, are guaranteed.  Their carrying interest (usually between 20-30% depending on the stature of the firm) on the appreciation in their portfolio kicks in only on the upside.  They share none of the downside risk of their portfolio companies, unless one factors in the possible damage to their reputation when their dotcoms become dotbombs.

Are Venture Capitalists Facing an Identity Crisis?

Venture Capitalists Facing an Identity Crisis

Published in Upside Magazine in 2002

Market Corrections and Pressures to Scale Up Force Reassessment of Priorities

by John F. Ince

Six years ago, when Alan Austin was Managing Director and Chief Operating Officer at Silicon Valley linchpin law firm, Wilson, Sonsoni, he wanted to get away for a ski weekend at Squaw Valley.  Get away he did.  In fact he got stranded for two days in blizzard like conditions.          Recalls, Austin, who now serves at General Partner and Chief Operating Officer of Accel Partners, “It was one of those mid-December days with raw conditions. It was snowing on the top of the mountain.  My companions were tired, so they headed back.  But I had something left in me so I went out for one last run. Well it turned into a whiteout.  That’s like a blackout, but it was all white and I couldn’t see anything.  I got disoriented and turned around 180 degrees. Without realizing it. I skied off the backside of the ridge, out of bounds–into no man’s land. I got more and more concerned.  Nothing was making sense.  At some point I decided that I wouldn’t find my way out that night, and if I didn’t make a shelter I would freeze to death.  So I made a cave in the snow.  I wound up being stranded there for two days and snowed 40 inches.  At the end of that time, it cleared a little, a National Guard helicopter spotted me, and  I was taken to safety.”

Not unlike Austin, the venture capital industry has suddenly found itself in a place far removed from where it hoped it would be 18 months ago. Down the slopes the VCs went, but, like Austin, they ended up on the wrong side of the mountain.   Is it a stretch to compare the recent markets for startup funding to the blizzard that Austin encountered?  Not many think so.   In March of this year, the slide of the NASDAQ achieved the dubious distinction of being most precipitous decline, in terms of percentage, of a major stock market, since the stock market crash in 1929.  Even entrepreneurs who feel they have a clear path to profitability,  have found themselves feeling disoriented in this forbidding investment climate. Market realities are accelerating trends and forcing many firms within the venture capital community to reexamine some of their most fundamental assumptions.

A Profound Transformation?

How deep that thinking goes will, to a large extent, be a function of how long the storm continues.  But this much is clear:  venture capital is undergoing a quiet and profound transformation.   Not that long ago in the 1980s, venture capital was a quaint little boutique industry, often with a few lawyers and doctors putting in $10,000 or $20,000 apiece.  More recently, VC firms started courting university endowments, pension funds, insurance companies and other institutional investors, who typically allocate 5% of their portfolios to these so called, “alternative investments.” According to Venture Economics, the number of venture capital firms increased from 95 in 1980 to 387 in 1989 to 620 in 1999.  And when smaller firms and angel investor groups are included, some estimate that there are well over 1000 VC firms operating today.

The amount of capital under management by VCs increased from $2.9 billion in 1980 to $29.5 billion in 1989 to $135.3 billion at the end of 1999.   According to Mark Heesen, President of the Natural Venture Capital Association,  “I’ve seen dramatic changes in a very short period of time.  In 1995 the venture capital industry invested $5 billion.  In the year 2000, we were a $103 billion industry.  The industry changed from a group of individuals who invested primarily in Silicon Valley and the Boston area, to an industry that invested in 47 states and the District of Columbia.”   The number of companies receiving venture capital  increased by 35% from 3,967 in 1999 to 5,380 in 2000.  Although venture capital investments did slow a bit in Q4 2000 to $19.6 billion, down from $28.3 in Q3,  the amount of capital under management increased to $134.5 billion.

Institutionalization of Venture Capital Firms

With this transformation, VCs are moving, sometimes reluctantly, towards institutionalization. The growth in size of VC firms has meant the adoption sophisticated management and accounting systems and along with that comes bureaucratic human resource policies and reporting burdens.  Dovetail these trends with the recent market corrections and it all adds up to a growing sense of VC disquiet.   Is is a stretch to call this a VC identity crisis?  You decide.  Some of the industry’s most influential players vociferously disagree.   But clearly the industry’s process of self-assessment has been intensified by financial uncertainty, especially with questions concerning the ability of the mid and lower tier VC firms to raise new funds in the coming years.

Crosspoint Partners, raised eyebrows this January with their decision to cancel a one billion dollar fund with commitments from bluechip institutional investors like Harvard University and the Rockefeller Foundation. Of course, the Crosspoint decision is not irrevocable.  Like most of the top tier VC firms, they have a waiting list of investors that they can tap at any time, so, in essence, it amounts to more of a postponement.  But Crosspoint’s decision has added fuel to an ongoing discussion that goes to the very character of the VC. Crosspoint’s General Partner, Seth Neiman declined to discuss their postponement of their recent fund in the recent Upside interview.  But six months after their decision, rumors continue to circulate.

Crosspoint’s decision  can be interpreted on two levels: professional and personal.  On a professional level, the speculation is that Crosspoint simply didn’t feel they could achieve returns to satisfy investors, and communicated this to their limited partners in an effort to preserve their reputation. This is what is so unsettling to others in the VC community who are no longer seeing the same quality of deal flow they saw a year ago.  Crosspoint’s decision is loaded with implications for institutional investors, especially because Crosspoint has such credibility.  If the LPs buy into Crosspoint’s logic and start asking hard questions of their other funds, what does that mean about the ability of  VC funds of unproven ability to raise funds down the road?

Then there are the personal issues facing VCs, who are often stretched thin, sitting on the boards of 12-15 portfolio companies. One industry VC who wished to remain anonymous, speculated that the decision of Crosspoint’s founding partner, John Mumford not to be a part of the next Crosspoint fund had an important psychological impact on the other partners.  Given Mumford’s decision to walk away from the stressful lifestyle, they also wondered just how much of a commitment they wanted to make, especially looking ahead at the possibility of several years of tough markets. The issue of time commitments of general partners is an especially vexing one for the industry.   According to Mark Heesen, President of the Natural Venture Capital Association. “Because the industry has grown so dramatically in such a short time,  the number of professional venture capitalists has not kept up with this incredible amount of money flowing into the industry. Professional venture capitalists today are more stretched than they ever have been.”

Says Seth Neiman of Crosspoint, “To work as hard as venture capitalists do, it’s going to take a lot of different motivations.  I simply wouldn’t work as hard as venture capitalists do, simply for the money.”  Speaking of the money, by postponing their $1 billion fund each of Crosspoint’s six partners were walking way from upwards of $3-4 million apiece per year in management fees ($1 billion times a 2-2.5% management fee, divided by six partners, less the expenses of running another fund).

Another more charitable theory sees Crosspoint’s move as a mature and responsible decision given the current market realities and the fact Crosspoint already has almost $500 million in their existing fund, yet to be invested.  But a more cynical theory sees the move as a self-serving, marketing ploy designed to differentiate themselves from the greedy pack of other VC firms.   Those of this persuasion wince a little at some of Crosspoint’s public statements that take the rest of the industry to task over the issue of management fees.  Whatever the interpretation of events, it is clear that Crosspoint has stirred controversy, by attempting to seize the high moral ground.

Pressures to Scale Up

The Crosspoint controversy also raises deeper issues about where the industry is headed.  Some of the industry’s most influential players are wondering if the same trends towards consolidation that characterized, commercial banking,  investment banking, law and accounting are lurking ahead for VCs.    Although venture capital may not be subject to the same economies to scale of investment banking, it is not immune to the market pressure to grow, especially in the critical area of deal flow. Says, Manny Fernandez, former President and CEO of Gartner and now a General Partner with SI Ventures and Chairman of Gartner,, “Although in the beginning,  the value add of the VC is operational involvement, in the final analysis, the venture capital industry is all about deal flow. ”

In an environment when many of the best entrepreneurs are waiting the sidelines it becomes increasingly difficult for smaller firms to sustain the quality of deal flow and this suggests that the pressure  will only increase for VC firms to scale up. Says Ronnie Skloss of Brobeck, Phleger & Harrison LLP, “We probably won’t  see outright consolidation of firms in venture capital, but we’re likely to see  increased raiding of talent by the VC  firms that better weather the fallout from the downturn in the technology sector.”

This becomes an especially attractive option for the top tier firms, who have no immediate problems raising additional capital.  Says Dennis Roberts, who brings 35 years of experience as an investment banker, commercial banker and more recently as head The McLean Group, “The economics of venture capital argue for the same scalability that VCs want for their portfolio companies. If a fund is small, it can’t hire enough good people to analyze and do deals.  By the time a firm has paid office overhead, legal fees, support services, acquisition costs and partner salaries, there’s not a lot of money left over at the smaller firms  for quality deal analysis.  I personally wouldn’t put my money in a firm with only $25 or $50 million under management.”

So the days of the boutique VC firm may be numbered as the industry places a growing premium on the speed through which they can move dollars through the pipeline.  Firms like San Francisco-based, Round1 are seeking to bring efficiencies to the private capital markets  by using the Internet to automate workflow and increased information transparency. But even Round1’s CEO, Jamie Cohan acknowledges, “There are established behaviors to overcome for an industry where personal relationship have played such an important role.  But those same behaviors create limitations. We believe it is inevitable that private capital markets will see the same level of standardization and information access  that you see in the public markets.” Not everybody agrees with that prognosis. According to Bob Kagle, General Partner at Benchmark, “I’m not sure that the venture capital business scales per se.  The unit of production in our business is the general partner’s time and availability to serve on the board of directors.  There are only so many boards that one individual can effectively serve on.”

If the VCs give in to the market pressures to scale up, how might that change the character of VC involvement with their portfolio companies?  And it also has potentially profound implications for the culture of an industry, where intuitional hunches, networking, and the nurturing of personal relationships are key determinants of success. Is this ultimately compatible with the sort of assembly line mentality that comes with pressures to increase deal flow?

Entrepreneurs Feeling the Pinch

And this disquiet has filtered down to the entrepreneurial community.  Many entrepreneurs now find themselves in situations like Alan Austin,  trying to live by their wits, building a financial cave in the snow,  hoping that National Guard helicopter with a few sympathetic VCs in it will spot them below. Many entrepreneurs have turned their business plans around 180 degrees from what they had when they set out to seek capital. According to Bob Kagle, General Partner at Benchmark, “Companies raised an enormous amount of money prior to proving themselves as a viable businesses.  What’s happening now is we’re reverting to the mean. You’re seeing both entrepreneurs and venture capitalists return to fundamentals and treat capital as a scarce resource.”

A Shakeout Ahead for Smaller VCs

Make no mistake about it,  not only for entrepreneurs, but also many of the newer and smaller VCs this is a game of survival.  Through a random sampling of VCs, a consensus emerges that of the estimated 1000-1500 VCs in existence today, as many as half will not be around in a few years.  In the history of investment banking or commercial banking is any gage, these projected attrition rates are probably inflated, but with exit strategies through IPOs all but blocked off, the portfolio pipelines of VCs are getting clogged.

For the moment, exit activity through mergers and acquisitions remains robust, but if the market slide continues much longer, even this avenue will become increasing littered with debris of dotbombs, and less viable.  The precipitous decline in the market value of firms like Cisco, Microsoft, Lucent and others who have traditionally been active in the M&A market further aggravates the VCs dilemma.  Until a liquidity event occurs, the VC’s capital investment is captive in the coffers of the portfolio company and subject to whole host of unpredictable factors including the viability of technology, the growth of the micro markets, the strength of the management team and the effectiveness of their sales and marketing effort.  Even after a liquidity event, with today’s depressed stock prices, VCs are reluctant to move stocks in their portfolios through either sales on public exchanges or M & A activity. Says Jeffrey Grody, Partner with Day, Berry & Howard LLP and a specialist in M & A activity,  “Although M & A activity is still strong, that really may not be what VCs want.  Sometimes, it doesn’t enable them to achieve maximum return.”

VC Taking a Tough Line on Valuations

Recognizing that their reputation with their institutional investors is on the line, most VCs are taking a tough line in negotiations. Some entrepreneurs feel that VCs are unreasonable, seeking to exploit the current market to extract deeper concessions from their portfolio companies in terms of valuations, especially in followup rounds of financing.  But VCs defend their stance, pointing out that the market is the ultimate determinant of values and that valuations in earlier rounds were clearly inflated.  Says, Jeff Grody, “In tough times, the golden rule applies.  Those with the gold make the rules.”

Although such figures are difficult to verify, an Upside sampling suggests that upwards of 50-60% of their investment funds are now going to prop up existing portfolio companies. Says Howard Schwartz, CEO and Founder of  ShareSpan Wireless, “Valuations of companies are divided by four or five from where they were last year.” Woe be those entrepreneurs who have neither a cash hoard or customer base with the sort of bluechip companies that will make skeptical VCs pause from their frenzy and take notice.

Few Options for Entrepreneurs

Although many talented entrepreneurs are on the sidelines waiting for market conditions to improve, others have little choice but to continue to make the rounds with VCs. According to Garry Hemphill, founder and CEO of VHB Technologies in Texas, “What we’re seeing now is that VCs want a slam dunk. Now they not only want you to be in beta testing with customer testimonials, but they’re also looking to mitigate their risks through partnerships with other VCs firms.  They need to know that when you need to go for the next round of financing,  that other firms VCs will be there.”   Says Schwartz, “VCs are asking a lot more questions.  They’re telling us to close the deals, book the revenues and then come back.  With this market, they know they can wait thirty days and your deal will still be there.”  One of ShareSpan’s investors and board members, Arnold  Kroll, Senior Advisor from Burnham Securities offered this admonishment to Schwartz, “Companies don’t go out of business from dilution.  They go out of business by not getting the money they need.” But most entrepreneurs accept the new market realities and realize that they have little leverage in the negotiation process.  Says Gary Hemphill, CEO of VHB technologies, “There plenty of bloodletting going on right now.  They don’t say no.  Their game is to sit on the fence and wait.  In the process they’re removing any bargain chips you might have have, in the negotiation process.”

Vivek Wadhwa, chief executive of Relativity Technologies in Cary, NC is more blunt.  He says, “”Companies absolutely are being raped by venture capitalists. The VCs wanted me to accept a lower valuation without even knowing what the valuation was, or how the company was doing. That is what pissed me off so much.  Their attitude was that we should take a cut and suffer the anti-dilution consequences just because they were losing money on their other investments.”  Wadhwa’s solution?  He went out and secured a $2 million working capital loan and $3 million line of credit instead.

Hoping for Divine Intervention

So, like Alan Austin, out there at Squaw Valley in his snow cave, both VCs and entrepreneurs are wondering if they are in fact doing the right things–without certain knowledge of how long the storm will continue.  Austin remembers hearing the sound of rushing water in his vicinity.  He knew that if the took a wrong step and fell into the stream, he was history.  So should he stay put and wait for a rescue or venture out? Should VCs be investing their time in raising new funds, when their reputation might be tarnished by bringing their investors lower returns?   Should VCs be pumping more capital into companies to keep them afloat, when nobody knows for sure when the market will bottom out?  Are they throwing good money after bad?  Says Manny with SI Ventures and Chairman of Gartner, “Our position is that if financing financing will not last the company  one year, and if the company is not profitable after that, we will not invest.  You have to make tough decisions in this environment and sometimes you just have walk.”

It was only after Austin was rescued, that he had time to reflect on the deeper meaning of what happened to him.    Says Austin, “Only in retrospect, did I come to appreciate the spiritual dimensions of the experience.  I really felt there was divine assistance at work with me out there.  I was only a casual churchgoer before the experience, but now I’m much more religious.”  While most VCs and entrepreneurs may not view what their going through as a spiritual experience, they also wouldn’t mind a little divine intervention.

Some Cool Shots I Took