Nice work If You Can Get It In an age of easy money, the clubby world of venture capitalists has given way to something more aggressive and cutthroat.
By Melanie Warner

(FORTUNE Magazine) – George Zachary found this year's Sand Hill Road Challenge a bit disappointing. The energetic 34-year-old partner at Silicon Valley venture capital firm Mohr Davidow had come to the event looking forward to some friendly jousting with his fellow venture capitalists. For months, rival VCs spend thousands of dollars building the fastest, most state-of-the-art soap-box-derby cars. On the day of the event they don silly racing suits and roll the cars down Menlo Park's Sand Hill Road to see whose can go fastest. Sure, the race is ridiculous--Zachary calls it the "Sand Hill Ego Challenge"--but he'd always found it appealing, in a clubby sort of way.

This year, however, Zachary wound up besieged--he was hounded by the same sorts of people who pester him all week for advice. They want to know this: How can they be more like him? In his offices, during the past two weeks, he'd met with the head of a European retailer who wants to find the next Amazon.coms and help them set up operations in Europe, and the CEO of old-line printer R.R. Donnelley, who is thinking of starting a VC fund. Lately, not a day passes without a call or e-mail from someone who wants to become a partner at an established firm such as Mohr Davidow. (Zachary's quick advice: Go start a successful company. Then we'll talk.) And here they all were at this event, this event that used to belong to the venture capitalists! There were investment bankers, Wall Street analysts, consultants, lawyers, and other assorted wannabes. They came from Merrill Lynch and Goldman Sachs and the law firm Brobeck Phleger & Harrison, which lent to Jamis McNiven, the eccentric founder of the race, a large camel that complemented the firm's Arabian-theme tent. "I want to tell them all, 'Go away,' " joked Zachary, navigating through the crowds and past McNiven on his camel toward Mohr Davidow's "car"--a collection of motorbikes strung beneath a red foam-rubber dragon with a protruding 20-foot tail. "I don't need the competition."

This is a story about what it's like to be a red-hot venture capitalist at a time so extraordinary that it seems everyone and his cousin wants to be a VC. Zachary and the four other VCs on the following pages are part of a group doing venture investing as it's never been done before. They're the guys everyone else wants to be, nurturing the next big things and making piles of money doing it. The top venture firms in the Valley are giving themselves and their investors annualized returns north of 100%. The really, really good ones--like the ones in this story--are clocking 200% or more. Venture capitalists have never before scored these kinds of returns, and it has made the best of them very, very rich. Investment bankers, the deal sharks who once sat at the top of the economic pecking order, look poor by comparison. The several million dollars that top bankers pull down is chump change next to the $20 million a year some VCs are making.

If the rewards are richer than ever, the work is more demanding than ever. The alpha VCs are pouring more and more money into young Internet companies, paying higher and higher prices for the privilege of doing so, and furiously running around to keep up with the companies they've already funded. The last deal Zachary did--Andale, an auction services company--came together in less than three weeks, from his first serious meeting with CEO Munjal Shah to the signing of term sheets. That is lightning-bolt fast--until recently, VC funding negotiations would poke along for three months. Geoff Yang, one of the Valley's most enduringly successful VCs, closed a deal even faster--in a mere ten days. He and two of his partners at Redpoint Ventures, a new firm that was spun out of Brentwood Venture Capital and Yang's old firm, IVP, held 10 P.M. meetings with the founders of Octopus.com, a personal-portal company, and almost rescheduled a firm off-site at the Pebble Beach golf resort. Yang and Zachary--who's also funding Jim Clark's new startup, Shutterfly, and spends time every day with CEO Jayne Speigelman--expect the pace to get even crazier. Yang is raising his largest fund ever. Redpoint Partners I will get $600 million from investors--it's astonishing that a firm's first fund could be so big, more than halfway to the billion-dollar mark that VCs are enamored of these days.

Just about every VC firm is raising its biggest fund ever. All told, VCs will spend about $23 billion to fund technology startups this year, $12 billion more than last year and $21 billion more than in 1991. If they keep spending at this pace, VCs will invest something like $35 billion next year. So if by chance you were thinking Silicon Valley couldn't possibly produce any more young, fast-spending, preprofit Internet companies trading at fairy-tale multiples, you're wrong. Armed with this much cash, the venture capitalists are setting out on their biggest shopping spree. You ain't seen nothing yet.

John Mumford is over at Buzzsaw's new San Francisco offices, shooting the breeze with CEO Carl Bass. Two weeks earlier, Mumford's Crosspoint Venture Partners firm funded Buzzsaw, a startup that intends to provide Web-based services and e-commerce for the construction and building industry. Now, readying for the first board meeting, he and Bass are verbally high-fiving each other about how well last week's launch went. "You should see all the builders we've got already posting their jobs on the site," says Mumford, wearing a wide grin. "For us to have this kind of demand this early is huge." In his 27 years as a venture capitalist, this is one of the biggest deals he's ever done. Crosspoint, which Mumford founded fresh out of business school in 1972, invested $15 million for an equity stake that gave the company a $65 million valuation. Mumford, 56, used to think that was a lot of money. He's been through some grisly years, when he wouldn't have dared invest $15 million into such an embryonic company, much less at such a valuation. And while Buzzsaw has the backing of Autodesk, the $765-million-a-year company that dominates the market for engineering design software, and is staffed with dozens of former Autodesk employees, it's still a company with no finished product and no revenues. For the deal to be a big success for Crosspoint, it will need to return 100 times the investment--that's what a big hit looks like these days. Which means that if Buzzsaw goes public, Mumford will be disappointed with a market cap of less than $8 billion.

Mumford wonders for a minute whether that seems a lot to expect from one investment. Then he remembers Foundry Networks, a Crosspoint company that went public just as he was putting together the Buzzsaw deal. Foundry hit the market with an $8.7 billion valuation and is now worth $10.6 billion. Crosspoint, an early investor, has netted $1.5 billion. That's on paper, of course (like employees, VCs typically can't distribute shares until six months pass), but after that sort of payoff, it's hard to think of $15 million as too much money. Mumford's still rather astonished, not just by the speed at which Crosspoint's $9 million ballooned by a 167 multiple but also by the fact that it happened on a deal such as this. Foundry makes complicated high-speed switches and routers for Internet networks, not the stuff most people are supposed to understand, much less get all twisted up about. "Deals like this are supposed to be worth $800 million, not $8 billion," he marvels.

Mumford's bets are typical of the way a lot of VCs are investing. He makes bold choices and has no intention of stopping. Already this year he's invested in 29 startups, just about blowing through $300 million he and his four partners raised in April. He's out raising another $600 million and would like to use it to find more companies like Buzzsaw--big, ambitious projects where he "owns" the deal. Crosspoint took the whole first round of financing without sharing the equity with any other VCs. Mumford's even thinking about using the new fund's money to do deals in which he carries the whole company, from first-round investment to an IPO or acquisition. If a company needed $60 million to get to an IPO, Crosspoint would provide it all. The idea would have been regarded as pure lunacy as recently as a year ago, but it's floating around at other firms too. Jay Hoag of Technology Crossover Ventures and Jon Callaghan at CMGI are both thinking about it. Mumford's not sure whether he'll end up actually doing it, but the idea has its appeal. Imagine: Had Crosspoint been the only investor in Foundry, the firm could have made $3 billion, not just $1.5 billion. The strategy allows for huge upside but obviously comes with bigger risks.

Or does it? Since its modern beginnings in the early '80s, venture capital has been universally understood as "risk capital." The buttoned-up pension fund managers and college-endowment investment officers who have historically provided VCs their capital made a point of never investing more than 5% of their assets in venture funds. These limited partners would typically invest 2% or 3% of their assets. Allocating any more than that would be too risky. The last thing you wanted was to own a big chunk of stock in harebrained failures like pen computing or multimedia CD-ROM companies. But at some point in the past two years, that 5% rule changed. The average pension fund or college endowment now gives VCs 6% to 8% of its assets. Some dare go as high as 20%. Risk capital, it seems, isn't so risky anymore. Encouraged by the returns of earlier funds, limited partners often implore VCs to take as much of their money as possible.

One reason limited partners once found venture capital so scary was that the business was a minefield of failures. Accepted VC math was that out of ten investments, four would end up losing money or breaking even. But ask VCs about their recent failures and you realize that isn't true anymore.

Yang, 41, recently told me he couldn't think of any failures. Then he remembered a company called Whistle Communications. While he was still a partner at IVP, Yang put $6 million into the company. Its product, an Internet server for small businesses, worked like a charm, but the company couldn't figure out how to sell it to the fragmented small-business market. So in June, Yang and the other directors sold Whistle to IBM for more than $100 million, a transaction that made IVP four times its money. With failures like these, who needs successes? Yang uses such stories to recruit executives from telecom giants like Lucent and Nortel to come work for one of his communications companies. Invariably, they ask about the risk of working at a startup. Yang tells them, "What risk? If the company doesn't work out, we'll sell it for $150 million. If the company kind of works out, we'll sell it for $500 million, and if it really works out, it'll be worth between $2 billion and $10 billion. Tell me how that's risk."

It's not just Yang who's finding venture capital less risky. He has one of the best track records in the business, but other VCs have similar troubles naming their last true disaster. Of the 76 investments TCV has made in the past four years, Jay Hoag has watched exactly two lose money for the firm--Pointcast and NetSystems. There's also at least one company that would have been a failure had Hoag not sold it to a larger company. Jon Callaghan of CMGI's @Ventures also has had just one bomb, a company called Freemark Communications in @Ventures' first fund. Several of his companies have been saved from failure by getting additional funding and starting over with a different strategy. Now they're on track and look as if they might pay off.

If you take away the risk, or at least reduce the perception of it, everything about the venture capital business takes on a different look. Consider what's happened, for instance, to the custom of deal sharing. It used to be that if you wanted to fund a company, you'd round up some of your VC pals to look at it, and then, as a way of managing the risk, three or four of you would invest. You'd chat about the deal at length and agree on a price everyone would pay, a practice that led to the VC community's seeming all too cozy. Some in the Valley liked to call it a cartel. Entrepreneurs love to tell stories about showing up for meetings with VCs, handing them a business plan, and then being informed that, oh, by the way, we've already read a copy of your plan. Today, thanks to the flood of new money and the fact that everyone wants to "own" deals, VCs aren't caring and sharing so much. Back in 1995, Yang asked Kleiner Perkins partner Vinod Khosla to take a look at six Stanford grads who had put together a search engine company called Architext--which became Excite. Today, Yang admits, he'd fund the whole deal himself. When VCs share deals now, it's not about risk, but time. When you're already on 12 boards, you might not want to take on the workload of a new company by yourself.

If the VC business was once a courtly tennis match, it's now more like a hockey game, and people are losing a few teeth. Zachary still talks about the time he almost got cut out of what became his most lucrative deal--Critical Path, which manages e-mail for corporations. He and a VC at another firm, which he doesn't care to name, had agreed to co-invest in Critical Path. The night before they were scheduled to draw up term sheets and make the deal official, the other firm had a change of heart. The partner called Zachary and told him that his firm wanted more equity and was going to take the whole deal itself, cutting Mohr Davidow out of the action. Incensed, Zachary bounded into his black Viper and roared down Sand Hill Road to the offices of a third firm, Benchmark Capital. He convinced partner Kevin Harvey to do the deal with him, and over the next two days the pair fought their way back in. When it was over, Zachary and Harvey strutted out of Critical Path Chairman David Hayden's office with their joint term sheet in hand. The offending partner from Benedict Arnold Ventures was sitting in the lobby. "I thought, 'I've done all this work--I'm not going to lose this deal. If you guys want to play, I can play,' " says Zachary, smiling about the crowning moment.

In this age of an endless supply of easy capital, VCs must compete for deals. Money alone won't cut it anymore. You have to prove that your money is better than everyone else's. Entrepreneurs want to hear about your "added value." Will you recruit, make calls on their behalf, sit in on staff meetings, have breakfast at Buck's with strategic partners at 7 A.M., and answer your home phone when it rings at 10 P.M.? If yes, then maybe you can invest. Maybe.

Jay Hoag is sitting in his office in Palo Alto showing me his new logo. Since starting Technology Crossover Ventures in 1995, Hoag hasn't had much of a logo at all really, just the firm's name punctuated with a thin red line. But earlier this year he and his eight partners decided they needed to make more of a statement. "We wanted something that indicated success and stability but was also pretty simple and straightforward," says Hoag, who spent 12 years at Chancellor Capital Management before breaking out on his own. So he hired a design firm to redo his firm's Website and come up with the new look and logo, a multicolored assemblage of letters and a giant green swooshing arrow. "You have to be more promotional and pound your chest," Hoag explains. "VCs have to build a brand. It's the price of admission."

VCs never used to talk about their "brand." If they had one, they certainly didn't refer to it in public or consider it a part of official business. Venture capitalists didn't hire PR firms; their idea of marketing was to repolish the sign over the door or throw a Christmas bash at the Menlo Circus Club. That worked when the entrepreneurs were doing most of the selling. It doesn't work now that a certain subsection of company founders can walk down Sand Hill Road and collect term sheets from whomever they please. In that environment VCs have to ask themselves this soul-searching question: Why should someone take my money?

To help the world answer that question, Hoag hired a PR firm called Blanc & Otus, which proceeded to get him on Wall Street Week with Louis Rukeyser. Hoag also went on CNBC for CNET's news.com show. He wrote a column for The Red Herring magazine. In the interest of branding, he also joined the board of iVillage just before its IPO. TCV was already an investor in the women's portal, but Hoag knew there'd probably be a lot of attention surrounding the IPO and figured some of that attention would reflect well on him. "When you're a board member, people take it more seriously, even though it doesn't necessarily indicate anything about your contribution," says Hoag. Branding himself isn't exactly the witty, self-effacing 41-year-old's idea of fun, but he feels the business demands that he do so. "There's a lot of people with capital," he says. "You have to differentiate yourself."

Despite his misgivings, Hoag has proved pretty adept at the marketing thing. He was amazed when a succession of entrepreneurs marched up to him with their laptops at this year's Agenda conference and implored him to spend 15 minutes listening to their PowerPoints. And in a sign that TCV has really made it, several companies have come offering "last looks." They already had term sheets from what they considered B-list VCs but were willing to let TCV invest at a lower price.

TCV's new profile also helped Hoag get into the Petopia deal. No one's quite sure why, but seven months ago a rash of companies arose with plans to sell pet supplies online. Pet portals, it seemed, were the next new thing in e-commerce. Every VC in the Valley had to have one. Hoag bought into the enthusiasm and homed in on Petopia. But there was competition. When he first met with Petopia's CEO, Andrea Reisman, she'd already had an audience with nine VCs and had come within days of doing a deal with one. But Reisman liked Hoag's candor. She also liked the fact that TCV often continues to invest in its portfolio companies after they go public. That's what accounts for the Crossover in the firm's name. In addition to its private-venture deals, TCV invests in the public markets and recently set up a separate fund to do more of it. It's a selling point, part of TCV's "added value." Entrepreneurs like the idea that their VC, a friendly investor if ever there was one, would own their post-IPO stock. That's a nice alternative to day traders who pile in and then flee and to institutional investors who buy IPO shares and then flip them. Reisman ultimately let Hoag put in $9 million and take the whole round. Just about every other pet portal got funded too. Pets.com got $60 million from Amazon and Hummer Winblad; Petsmart took $10 million from Idealabs Capital Partners; and Petstore raised $10.5 million from Battery Ventures and Advanced Technology Ventures. Petopia, for its part, spun around two months later and raised $66 million from Petco and French luxury-goods seller LVMH.

One VC who didn't look at funding a pet portal is Mumford. Crosspoint's deals in the past three years have fallen into three distinct categories--Web-based enterprise applications and services like Ariba, next-generation carriers like DSL company Covad, and business-to-business Net exchanges like National Transportation Exchange. Crosspoint has never funded a consumer Website. No finance portals, no MP3s, no online furniture. Mumford knows he's missing out on boatloads of money, but he "just can't get comfortable" with the businesses of most dot-coms. Mumford, who grew up in an age when technology investing meant investing in technology, doesn't understand the dynamics of banner advertising or of sites trying to sell watches or makeup. He doubts that those businesses will ever make real money. And isn't that still, after all, the point of starting a business?

For all his deliberate snubs of consumer e-companies--or "foo-foo dot-coms," as he takes great amusement in calling them--Mumford decided earlier this year to jump into the action. He chose online home improvement, because if there's one business Mumford knows, it's hardware: He's built garages and wired basements, and figures he owns more bags of nails than any other VC. The young CEO of HomeWarehouse.com, Richard Shane, seemed smart and charismatic, and Mumford liked him immediately. After two weeks of meetings, he and Shane had a handshake deal.

Then Mumford got cold feet. He was sitting in his Woodside office one afternoon thinking about the deal, and doubts flooded into his head. Hopping into his 1997 Aston Martin, he went home, put on a denim jacket, and headed over to Home Depot in San Carlos. He walked around the store and talked to customers, eager to know how many might buy hardware online. The results were not good. About 80% didn't own a home PC, and just about everyone he talked to said that he saw no reason to buy hardware online. The next morning Mumford called Shane and pulled out of the deal. He'd decided that the online market for hardware wouldn't be that big, and that he didn't see how the company could take enough costs out of the system to make money. "When you put all the infrastructure back into these companies--delivery, distribution, and call-center support--it gets very expensive," says Mumford. "At some point the hype stops, and earnings, performance, cash flow, market share, and growth become the factors you've got to settle down and value these companies on."

Even if he's right about HomeWarehouse.com, Mumford knows he probably could have made money on the deal. If HomeWarehouse does everything right, and if the public market's enthusiasm for e-commerce stays high, there's no reason to think that the company can't go public with a billion-dollar valuation. And when that happens, Sequoia and Accel, the two VCs who stepped in after Mumford jumped ship, will make hundreds of millions of dollars. But whether HomeWarehouse can ever make money is another question. Since the stock market doesn't expect young Net companies to be profitable or even show much revenue, lots of them go public before their businesses have ever been tested. Just when will they be tested? Probably long after VCs and other private investors have distributed their chunk of stock among themselves.

That is one rule of the venture game that makes playing it so lucrative: If a company goes public at all, VCs make money. Venture capitalists are part of a very active food chain. Since their money goes in first, they sit at the top of it. As long as someone else is willing to come along in the public markets and pay a generous multiple of the original price, the VCs will do quite well. If the stock later deflates, it's not the VCs who'll be holding the bag. "You want to be the second-to-last fool," says Bill Davidow, the 64-year-old founder of Mohr Davidow. Does that mean that what's good for VCs is bad for the investing public? In some cases, yes.

That's not to say that funding Internet companies constitutes some kind of New Economy Ponzi scheme. Most VCs don't fund companies that haven't a prayer of turning a profit. They believe that, while it may take years and untold millions, the companies they back will sell high enough volumes of goods or find enough creative ways to capture ad dollars to live up to the promises laid out in their business plans. Jon Callaghan certainly believes that the 36 consumer dot-coms and ten business-to-business Internet companies his firm, CMGI, has funded in the past four years will be able to do that. "We're completely devoted to our companies long-term, and we certainly expect them to become huge successes for everyone who invests," he says, with such pleading earnestness that you want to believe too.

Few have been doing more Net deals than Callaghan and his eight partners at @Ventures, the Silicon Valley venture arm of Boston's CMGI. This year it has been on a tear, adding about four new Internet companies a month to the growing "CMGI family." For every imaginable market in consumer e-commerce and Web content, @Ventures has a company--sporting goods, cars, crafts, watches, ticket sales, expert advice, genealogy, you name it.

One of the Valley's youngest VCs, Callaghan, 30, joined CMGI at just the right time. Few people had heard of the company when he was offered a partnership fresh out of Harvard Business School in 1997. Some MBA friends thought he was crazy to turn down offers to be an associate at several of the Valley's better-known VC firms. But Callaghan's boss, CMGI CEO David Wetherall, had discovered the joys of Internet investing after his $4 million investment in a little search engine called Lycos swelled into $1 billion, and was in the process of turning CMGI into one of the most admired brands in venture capital. Between the 12 properties owned by CMGI (the biggest is AltaVista), and the 52 companies in Callaghan's portfolio, CMGI claims to have the fourth-largest audience of any Internet company (MediaMetrics backs him up on that). This reach is Callaghan's "added value." Several times a year he holds summits where execs of the CMGI companies gather. Callaghan says that at a recent powwow in Scottsdale, Ariz., more than 20 deals were done among the companies. AltaVista, for example, reserved slots on its site specifically for some CMGI and @Ventures companies.

The last boom cycle in venture capital lasted about five years. In the late '70s and early '80s the business got frothy, lots of new firms piled in, and every VC was really happy. Then the market for small-cap stocks blew up. It became difficult for VC firms to raise new capital, and those eager new VCs went off to do something else. While the Internet may change everything, most VCs who are old enough to remember the last cycle know it can't stay this good forever. Mumford, for one, remembers having to crawl on his knees to raise money for funds. That's why he recently spent three days flying around the country to visit each of Crosspoint's limited partners. He could have raised his $600 million by just picking up the phone, but he wants his investors to think favorably of Crosspoint when the rainy days come. "If the market gets really ugly, those with money will be kings," agrees Hoag, who acknowledges that insurance against such dark times is one reason TCV is considering raising a billion-dollar fund.

Zachary contemplated this back in September as he stared at all the VC wannabes at the Sand Hill Challenge. "As long as everything's going up, you're foolish not to invest," he said. No one's ready to stop partying just yet. The music, you see, is still playing.