Last year I attended a conference of technology companies at which the focus was Japanese billionaire Masayoshi Son and the businesses in which he and the Japanese holding company he controls, Softbank, have invested. Most were Internet companies; the most successful of them was Yahoo -- an investment in which Son had made $2 billion. For two years the Silicon Valley old guard -- professional investors used to funding networking companies and chip factories -- had scoffed at Son, ridiculing the prices he was paying for his Net investments.
At this conference, however, Masayoshi was basking in triumph. He owned a third of the stock in Yahoo, then a $6 billion company. He owned a third of GeoCities, too, a Web-hosting service that had inspired the public markets to go gaga (and which has since sold out to Yahoo). Son was finally being accepted as what he wanted to be: a true Net mogul.
As Son spoke, slides flashed on a screen behind him. There were slides with circles, slides with line charts, slides with equations and summation signs. But there was one particular slide that got the audience palpably excited. It showed a small square with the names of some old school industrial companies written below it, a bigger square with new companies like Dell Computer, a still bigger square with the names of huge media companies, and a last, biggest square with the next wave of Net companies. The squares were supposed to represent the relative values of each generation of business giants. And the point, ultimately, Son claimed, was that the top companies of the Net generation would have a market value 10 times that of their predecessors. Of course, it was all hype. But the audience loved it.
I could not help thinking of Masayoshi Son earlier this month when three investors -- Son's Softbank, plus the investment bank Goldman Sachs and the venture capital firm Sequoia Capital -- let it be known that they had paid $275 million for 6.48 percent of the stock in Webvan. Webvan, as many readers of the business pages know, is an online supermarket headed by Louis Borders, founder of the Borders chain of bookstores. Webvan currently delivers groceries to customers in the San Francisco Bay Area. In investment speak, Webvan is a national online retail play trying to capture a big piece of the $350 billion dollar a year grocery market.
But more precisely, Webvan right now is a very big warehouse in Oakland, Calif., a headquarters office in Silicon Valley, an attractive logo, a fleet of trucks, some 300 employees, a computer system that links all these pieces together with an e-commerce Web site, a contract with construction giant Bechtel that commits the fledgling company to building 26 more warehouses at a cost of $1 billion, and a lot of hope. That's it. Six and a half percent of this is worth $275 million, which gives the whole thing a nominal value of $4 billion. That's an awfully pricey warehouse.
If you are scratching your head wondering how a warehouse with operations in just one small part of the country can be worth so darn much money, however, you're probably wasting your time. There are certainly ways to calculate the potential value of the business. You can look at the value of Safeway, the giant grocery store chain, whose stock has a total value of $26 billion plus. You can, conversely, look at Peapod, the first online grocer, a service that the Wall Street Journal plugged in 1994 with the headline "Peapod's On-Line Grocery Service Checks Out Success," whose stock is muddling along at a single-digit share price. You can talk about profit margins and argue about whether online groceries will succeed in achieving the 5 percent profit margins they hope for -- though most backers of online groceries will tell you that traditional supermarkets have margins of just 1 and a half percent and Safeway's are at 3 percent. The problem is that all of this entirely misses the point.
In fact, there is one overriding reason why this warehouse in Oakland is worth $4 billion: The money managers who have invested in Webvan have already made a whole lot of money in other Net companies. And so, like Son at his conference, they give the entire project a halo of invincibility, no matter how preposterous the financial assumptions. Those money managers are two Silicon Valley venture capital firms, Benchmark Capital and Sequoia Capital.
Venture capitalists right now are the darlings of the business world. In fact, to call them simply "money managers" is asking for a fight. Venture capitalists insist that what they do is not manage money but build companies, and this is partly true. They certain provide management advice, some of which is good; they help recruit employees; and they contribute, to the best of their abilities, at board meetings. But their reason for existence is, put bluntly, managing money, much of which represents the investments of university endowments, pension funds and some of the large number of extraordinarily wealthy individuals. They invest this money in companies -- including many technology companies -- at an early stage of their development, hoping to multiply their funds 10- or 20-fold with every successful investment.
In Silicon Valley there is a definite pecking order among venture capital firms, and Sequoia and Benchmark are near the top, getting into the most sought-after deals. (Kleiner Perkins Caufield and Byers, which made its money and its name on early investments in Netscape and Amazon.com, has long been at the pinnacle.) Sequoia and Benchmark are on top now largely because each of them has had a single stunningly successful Net investment. For Sequoia, it was Yahoo; Sequoia provided $1 million of startup money for a 25 percent ownership in the company; Yahoo's stock is now valued at $26 billion. Michael Moritz, the Sequoia partner responsible for backing Yahoo, is also the partner who sits on Webvan's corporate board. Meanwhile, Benchmark is one of Silicon Valley's younger venture capital firms -- just four years old. Benchmark was the initial investor in the auction site eBay; its share is now worth about $880 million.
But here's the big irony of the Silicon Valley pecking order: The biggest advantage of having backers from the club of top money managers is the mystique they bring. By their vote of confidence in a company, the top venture capitalists attract other investors, who put in even more money in later rounds of financing. Webvan counts as investors not only Softbank and Goldman Sachs, but also the French billionaire Bernard Arnault, newspaper company Knight-Ridder and CBS. All of them have ponied up tens of millions in financing to go along for the ride with Benchmark and Sequoia.
Well, guess what. Once a company has raised over $400 million, it's almost certainly only a very short step away from selling stock to the public. Chances are that investors will bite once business magazines report that a company has a "value" of $4 billion. What that means is that the last 6.48 percent of the company was sold for $275 million, which implies that the whole company is worth $4 billion dollars -- even though Benchmark and Sequoia got big pieces of the company early on, for much, much less. If the company does go public, the investors in the public markets will no doubt be eager to get stock in a company that comes with the imprimatur of gilt-edged money managers. On top of it all, the fact that Webvan and Yahoo share Softbank as an investor (in fact, Yahoo CEO Tim Koogle has a seat on Webvan's board of directors) implies a deliriously full future for investors eager to bet on the future giants of the Net.
A scenario a lot like this played out last week, when investors bid up shares in Drugstore.com, an online pharmacy backed by Amazon.com and Kleiner Perkins, the most prestigious and powerful of all of Silicon Valley's venture capital firms, by 179 percent in one day. The stock of Drugstore.com, a company that opened for business five months ago, is now worth just over $2 billion. (Amazon and Kleiner Perkins have also teamed up on a direct competitor to Webvan -- HomeGrocer, which is already operating in Seattle.)
There is not a single venture capitalist who does not say that his goal (they are mostly men) is building "the next Microsoft." But here's the ugly truth: It makes no difference to a venture capitalist's returns if a company grows to dominate an industry or goes bankrupt five years after selling stock to the public. A Boston Market (formerly Boston Chicken) can be as good as a Microsoft because a venture capitalist needn't wait for the company to prove itself; not long after a company goes public, the venture capitalists can cash out. In fact, a Boston Market -- a high-flyer which went bankrupt -- can be better than a Microsoft, because all of Microsoft's stock taken together wasn't worth a billion dollars until the company had been around for nine years.
What venture capitalists are looking for is -- don't laugh -- a "liquidity event." That's biz speak for selling a company or taking it public, turning their ownership stake into cash. Typically, a year after a company goes public, venture capitalists are allowed to sell their stake. Sometimes they will do that. More often the venture capital firm will split the stock up among investors in its fund, letting them quietly sell it in small bits and reap huge winnings. Or they might hold it, if the investors think the company really will be the next Microsoft.
The upshot is that venture capital firms are not in the business of taking a long time to build companies. At one time, they might have been, but that is certainly not true in the age of the Net. Like Masayoshi Son at the San Francisco conference, they are in the business of retailing dreams of corporate grandeur. If they succeed in selling those dreams, they can make a lot of money. Whether they come true, however, rarely need be their main concern.
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