Google's Banker As money pours into venture capital, some of the biggest in the industry are starting to worry. Just ask...
(FORTUNE Magazine) – The all-time greats of Silicon Valley venture capital can pretty much be counted on one hand. There's Arthur Rock, who was present, checkbook in hand, at the creation of Intel. Don Valentine seeded Oracle, Apple, and Cisco--a VC trifecta for the ages. John Doerr made a fortune with early bets on Sun, Netscape, and Amazon.com. And when search star Google goes public--the waiting on that one should end shortly--sculptors will need to get busy on one more bust for Sand Hill Road's Mount Rushmore: Michael Moritz, the wily investor whose previous grand slams include early stakes in Yahoo and PayPal.
In 1999, Moritz led his firm, Sequoia Capital, to invest $12.5 million in Google. If Google goes public at the $8-billion-and-up valuation that investment bankers expect, Moritz and his partners will likely reap hundreds of millions of dollars. With that kind of payday around the corner, it is easy to understand the giddy mood in the ballroom of San Francisco's Fairmont hotel in late March. There, 100 or so fund managers for university endowments, charitable foundations, and the like have gathered for updates on their investments in Sequoia Capital. Among other activities, they are dazzled by a Q&A session with Google co-founder Larry Page, pitched on the virtues of conducting IPOs as auctions by investment-banking legend Bill Hambrecht, and enthralled by a peek into Sequoia's latest bets.
But leave it to Moritz to pour cold water on the merriment. His narrow face and high forehead make him look like a bird of prey sporting oversized round spectacles, and Moritz stands in the front of the room to deliver a sobering message: Audience members are wasting their time--and, more important, the money they manage--on venture capital. He amplifies his point with a simple image projected on a screen behind him. It shows a billfold below four boldfaced words: SIT ON IT (PLEASE!). "The notion that people should load up on venture capital as part of their overall portfolio-allocation process is just a batty idea," says Moritz later. A 49-year-old Brit, he wields his accent with rapier-like effect. "I mean, it's a recipe for disaster for themselves and the venture capital business. Any trustee of a university or any person on the investment committee of a major institution should fire the investment officer who recommends that they invest in venture capital."
The performance is pure Moritz. It's self-serving: An explicit element of his spiel is that it's fine to invest with him and his firm, just not with most of the other VCs on Sand Hill Road--venture capital's main thoroughfare--in Menlo Park, Calif. It's pugnacious: His pitch for Sequoia is a diss on the very competitors he and his partners will be sitting down to do business with the next day. (Says Dick Kramlich, a veteran VC at New Enterprise Associates, of Moritz and Sequoia: "It's great for them to preach their gospel, but it has nothing to do with us.") And the money argument is, well, probably true: Once again, Silicon Valley is throwing more money at technology startups than entrepreneurs can possibly handle. And expectations are again shooting skyward.
What does Moritz get out of this act? A lot of scared investors likely to respond to a very comforting message: that to be safe, they should keep betting on him and Sequoia. Sure, Moritz has had high-profile misses, but he has also built a net worth in the hundreds of millions of dollars (by some estimates he's worth more than $1 billion) by finding big scores--often in companies that other VCs have rejected. Venture capital is a nail-bitingly unpredictable business that rewards bold if unexpected moves by unconventional thinkers. And Moritz is as bold, unexpected, and unconventional as they come. "Mike, more than any VC I've ever worked with, is willing to make that gut decision that a lot of VCs will only make after they see three other VCs do it," says Randy Adams, CEO of AuctionDrop and a seven-time Silicon Valley entrepreneur. "The VC business is like very high-stakes poker with somebody else's money. You've got to have a knack for knowing when to play. And he has it."
Michael Moritz's office is practically bare. He works at a tidy, bleached-wood desk with two bottles of San Pellegrino within reach. There is nothing on the walls. And his take on the VC world is similarly stark. Ask him to elaborate on the state of venture capital, and he puts his feet up on a nearby chair, swivels his face into a profile, and rails against those who are ruining the business. "Arrivistes!" he calls them, with a signature sneer that evokes Captain Hook in Peter Pan. "There are more cavalier hip-shooters around today than there were 18 months ago," he says. "More money is coming back in as people begin to think yet again that this is a fairly easy place to make investments."
It wasn't always like this. In the early years of Silicon Valley, venture capital was run by a small group of mavericks on the fringe of the investing world. In 1981 only 75 firms raised money, and what they raised--a total of $1.5 billion, according to Thomson Financial--would be considered a pittance today. But as their little investments turned into Oracles and Ciscos, more money and people started to flow in. For the next decade an increasing number of institutions decided they needed to add venture capital investments to their portfolios of T-bills, annuities, and index funds. The Internet boom, starting with the IPO of Netscape in 1995, added even more fuel and convinced wagonloads of MBAs, ex-entrepreneurs, and even financial executives at big companies that they, too, could be VCs. In 2000 venture firms raised $105 billion in 631 funds--three times the amount of money and twice the number of funds raised just two years earlier.
When the bubble burst in 2000, the industry practically collapsed. With no IPOs or buyouts--charmingly referred to in VC-speak as "exit strategies"--many investors saw their stakes evaporate. The 186 firms that went out hat in hand in 2002 collected just $9 billion from investors. Returns also dried up. In the past three years the fund industry has averaged a --30% return. Yet as the IPO market revives and tech stocks show strength, money also appears to be trickling back into venture funds. In 2003 new funds raised $11 billion, and 53% of the firms recently surveyed by researcher VentureOne say they'll start a new fund this year. (See the fold-out chart for graphic details on the state of the venture market.) On top of all this there's still $68 billion in uninvested capital left from the last spate of fundraising.
With dunes of cash piling up on Sand Hill Road, hot entrepreneurs once again have VCs tripping over one another to invest in the next big thing. This is where Moritz switches off the sneer and turns on the charm. In meetings with startups, he explains quickly that they can learn from his successes and even from his failures. Then he reels off names of people that they should feel free to call--a list sure to impress even the most battle-scarred entrepreneur: former Yahoo CEO Tim Koogle, CEO Michael Marks of contract manufacturer Flextronics, PayPal co-founder Elon Musk. Of course, name-dropping will take you only so far. Moritz also knows how to telegraph the toughness and decisiveness that smart entrepreneurs crave in their backers.
That's what won him a spot in the boardroom of Pure Digital. In 2001, Jonathan Kaplan started the company to make a single-use digital camera that would sell at retailers like Walgreen's and Ritz Camera. A four-time entrepreneur, Kaplan auditioned 40 potential VCs. None impressed him as much as Moritz. "He's very direct," says Kaplan. "He does not waste your time or his time." Moritz was particularly speedy in providing Kaplan with a written offer, known as a term sheet. "Mike said, 'I don't want anything in there that's crap,'" says Kaplan. "A lot of VC firms are protecting for the downside even in the first round, when there's not all that much to protect."
For many entrepreneurs, the goal isn't protecting the downside, of course, but creating as big an upside as possible. The Moritz name--rightly or wrongly--is often seen as a way to help ensure success. When Steve Streit, the founder of prepaid credit card firm NextEstate, needed financing, he was ready to go with two other venture firms until Moritz swooped in with a proposal to be the solo investor. Streit quickly dumped his other suitors. "If you are looking at two TVs and one is a brand you've never heard of and the other is a Sony, most people are going to buy the Sony," he says. And so far, he's been happy with the Moritz brand; when Streit sent an e-mail to Moritz asking for a commercial-banking referral, Streit's phone started ringing with offers 90 minutes later.
If Moritz is willing to take a different tack with his entrepreneurs, it's because he himself took a circuitous route into the industry in the first place. As he puts it, "My passport wasn't filled with the necessary stamps to get admission to Silicon Valley"--such as formative years spent at places like Intel or Hewlett-Packard or other techie training grounds. Born in Wales to German-Jewish refugees, Moritz initially chose a path that would likelier lead to poetry than to PowerPoint. He studied history at Oxford and edited the university's literary magazine. In pursuit of a graduate degree, he won a scholarship to the University of Pennsylvania, where he focused on history before enrolling in the Wharton School.
From the start in America, he stood apart from the crowd. Bob Bowman, CEO of Major League Baseball's online subsidiary, played rugby with Moritz at Wharton. "He would certainly have been the only one on the team who could find the Philadelphia Museum of Art," he says. Instead of shooting for banking or consulting jobs, Moritz took his MBA and went back to his writerly roots, joining Time magazine.
Moritz quickly became known as a guy who could cut through business-speak. Early on, the magazine dispatched him to Detroit to analyze the finances of the Big Three automakers. Moritz discovered that Chrysler was a mess and later captured it all in Going for Broke, a book he co-wrote with the Detroit bureau chief, Barrett Seaman. In 1982 he moved to San Francisco and performed the same tricks on the new economy that he had on the old. His next book, The Little Kingdom, explored the differences between hype and reality at Silicon Valley's then-golden company, Apple. "He was absolutely unafraid," says Seaman, now retired from Time and still a close friend. "He had the journalist's instinct to go for the jugular and not hold back."
Writing about money led Moritz to think about pursuing it. In 1984 he penned a profile of the venture capital industry's founding father, Arthur Rock. Moritz became enamored not only with the industry but also with some of Rock's mantras: He espoused investing in companies that were close to his office to reduce travel, keeping a tight rein on spending, and conveying, wrote Moritz, a "harsh sense of urgency." Months later Moritz quit Time, first to help start a VC newsletter and then to go full-bore VC.
In 1986 he persuaded Sequoia Capital's Don Valentine to let him have a crack at the business. Moritz knew that he'd be learning from one of the best. Valentine had started Sequoia in the early 1970s after peddling chips for Fairchild Semi-conductor and co-founding National Semiconductor. He was known for being particularly tough. Richard Shaffer, the editor of VentureWire and Moritz's former partner in the newsletter business, recalls hearing about a CEO who vomited after being on the receiving end of a Valentine tirade. (Valentine is unapologetic about challenging people.) Valentine also took a different approach from his peers on making investments: He bet on the racetrack, not the jockey. "My position has always been that you build great companies by finding monster markets that are in transition, and you find the people later," says Valentine.
He took a big gamble, however, on Moritz. One of Valentine's original partners, Gordon Russell, told him he was crazy to even consider hiring an ex-journalist. But in Moritz, Valentine saw a resemblance to another precocious go-getter he had observed at close range: Steve Jobs. "They're both incredibly aggressive questioners," says Valentine. "And our business is all about figuring out which questions are relevant in making a decision, because the people who are starting a company don't have a clue what the answers are. Steve always has been an incredible questioner. Draining, exhausting. Same characteristic that I recognized in Moritz."
Within a few years, Moritz became a full-fledged partner. He had done well: In 1993 he saw that PC makers would soon be outsourcing production and so pumped Sequoia money into Flextronics. But his big break would come two years later with his decision to invest in Yahoo.
At the time, the company was little more than two Stanford graduate students working out of a trailer behind the computer science department. Founders Jerry Yang and David Filo had entertained a few VCs, but the people with money saw in Yahoo little more than another search company, of which there were many. Moritz, though, saw a possible media empire, and he helped Yang and Filo see the same. "Everyone at the time said, 'How can you invest in something that's free?'" says Moritz. "I said, 'Radio and TV are free. It's no more complicated than that.'" He also foresaw that the company would thrive by not being a copycat. At one of their first meetings following Sequoia's investment in Yahoo, Yang told Moritz he was concerned that the wider world might find Yahoo's name a bit frivolous. "He said, 'If you change the name, I'll take my money back,' " says Yang.
It's a trademark Moritz moment, the kind that gives the VC a fearsome reputation among entrepreneurs. Peter Thiel, former CEO of PayPal, recalls a board meeting in late 2000 when the startup was hemorrhaging cash. Moritz declared that any member of the management team who didn't "start rowing really, really hard" would summarily be tossed overboard. "There was this shocked silence," says Thiel, now a money manager and venture capitalist himself. "This definitely was not a touchy-feely person."
While Moritz had giant hits during the dot-com boom, he also whiffed embarrassingly. Between 1997 and 1999 he ponied up $53.5 million for a stake in Webvan, which intended to revolutionize grocery delivery. The company famously expanded nationwide even before it had found a hit in any single market. Soon its name became a tech-world punchline, and in the summer of 2001 Webvan went bankrupt. Says Moritz: "The venture business as a whole is a humbling business."
In addition to Webvan, Moritz also made money-losing bets on clunkers like defunct toy seller eToys. He concedes that like many, he got caught up in the dot-com frenzy. In doing so he set aside some of Valentine's principles, such as only targeting businesses with fat margins. Moritz says the failures have reinforced his own investing rules: Avoid capital-intensive businesses, take measured steps, never underestimate the difficulty of changing consumer behavior, don't begin a rollout until you're sure the recipe is working. The biggest lesson? "Any business Wall Street is prepared to throw hundreds of millions of dollars at is not one we should be in."
Which, of course, raises the question: What about Google? When Moritz first took an interest in the search engine, the investment-banking world had its hands full with hot IPOs and didn't care about the two kids in Palo Alto. In what may yet go down as the most successful venture investment ever, Moritz and Kleiner Perkins's John Doerr invested a total of $25 million in Google in early 1999, a deal that valued the company at $75 million. Considering that investment bankers believe Google today is worth anywhere from $8 billion to $20 billion, the investment looks in retrospect like a no-brainer. But at the time Google had no revenues and only a hint of a business plan. Says Benchmark Capital's Bill Gurley: "It took a combination of conviction and courage to commit to such a high valuation at that point, and now they are being rewarded."
Moritz and Doerr invested at a time when most venture capitalists thought the search business had been played out. "I'm amazed at Mike's ability to see value where I can't," says Stewart Alsop, a venture capitalist at New Enterprise Associates who, like Moritz, is a former journalist, and, like Gurley, a former columnist for FORTUNE. "Our partnership would never have touched Google. It had no revenue, no fully implemented product, and no business model." (Moritz won't discuss Google, for fear of running afoul of securities regulators once the company files its IPO documents.)
One thing is clear: Even with the returns Google will generate, Sequoia continues to feel the dot-com pain. Its $350 million 1999 fund is so weighed down with bad dot-com bets that it was underwater as of the end of 2003. To ensure that it doesn't get caught in another technology-bubble bloodbath, Sequoia has ratcheted back the total amount of money it wants to invest. When the firm set out in 2003 to raise a new fund, institutional investors offered $3 billion. Sequoia accepted only $395 million--down from the $695 million it raised in 2000.
Perversely, Google's success is likely to bring Moritz headaches as well. It will increase the flood of wannabes whom he sees as invading the Valley--and the glut of money. "I can't imagine that the natural appetite of Silicon Valley requires more than $700 million a year to fuel the really good new companies," he says, acknowledging that the number is a guesstimate.
No matter how hot things get, Moritz plans to keep making investments as long as they fit his maverick style. That's the way he lives his life. He has no goal of, say, picking up golf, the pastime of choice for many of his peers. Instead he paints still lifes, arranges flowers, and is learning to play the saxophone. Other VCs acquire vineyards in Napa; Moritz owns a village in Tuscany, where he invites writers and other artists to escape from the modern world. Most VCs live in the suburbs, near their Silicon Valley offices. Moritz lives in San Francisco with his novelist wife and their two school-age sons. And from his office on Sand Hill Road, he keeps extending the saga of Silicon Valley--a story in which he has become one of the main characters.